It is often said that mutual fund is the best investment vehicle for new investors as well as small investors. One does not require any special knowledge about the finance or investment domain to be able to invest in mutual funds. Moreover, there is no special cap for investing in any fund. You can enter the market with as little as ₹500, via mutual fund in a SIP mode.
All these proclamations are true; however, what confounds a new investor or even a seasoned one is the sheer number of mutual fund categories and sub-categories available in the market. Through its October 2017 circular – Categorization and Rationalization of Mutual Fund circular – Schemes Securities and Exchange Board of India (SEBI) has tried to simplify the fund picking process for investors in an industry that manages asset worth of ₹23 trillion.
In the effort to do so, the regulator has categorized the fund offerings in six broad categories: Equity Mutual Fund Schemes, Debt Schemes, Hybrid Schemes, Solution Oriented Schemes, and Other Schemes. These categories are further subdivided giving 10 types of funds under Equity Mutual Fund Schemes, 16 types under Debt Schemes, 6 types of funds under Hybrid Schemes, 2 under Solution Oriented Schemes, and 2 under Other Schemes.
SEBI’s effort to recategorize and consolidate existing mutual fund categories may put a new investor in a bind as the exercise has created more than a handful of new schemes.
Which Equity Mutual Fund is Best for You?
Although there are 10 kinds of equity mutual fund and 4-5 of equity-oriented hybrid funds to choose from, a new investor should invest its money in traditional funds such as large cap, mid cap, small cap, multi-cap funds, and sectoral funds. Funds in these categories will help you achieve your long-term objectives of wealth creation and capital appreciation, without much sweat.
As per the new circular, a large-cap fund needs to invest a minimum 80% of its total net asset in the top 100 companies by their market capitalization. A mid-cap fund needs to allocate a minimum of 65% of its total net asset in companies ranking 101 to 250 by their market capitalization. A small cap needs to allocate a minimum 65% of its total net asset in companies that are 251st in rank or lower, as per total market capitalization.
You might have guessed from the above distinction that large-cap funds will be relatively safer while a small cap fund and a mid-cap fund might give a higher return when left for a longer period. In short-term, small-cap funds and mid-cap funds lose value as the market tends to punish them heavily during volatility. They amass value in quick succession when the market rebounds. After every cycle NAV of such funds improves making them lucrative for a long-term investor. Apart from these, there are multi-cap funds, which help you balance your risk and reward ratio by investing in all three kinds of companies. Then there is the new large & mid cap fund category, which allows you to invest in both large and mid-cap companies.
Large & Mid-cap Fund vs Multi-cap Fund
Just because large and mid-cap funds are the new addition to the long list of mutual fund options an investor has, it does not necessarily mean that these are the ones that will fetch better returns. Future will only tell you that. The realignment of mutual fund schemes across the board has brought a wide range of funds into this category. It goes without saying that different kinds of funds have a different style of investing and different goals, and when they are combined under one umbrella of large and mid-cap funds, they might create confusion in the mind of investors.
Let us understand this with the help of an example. Mirae Asset Emerging Bluechip Fund, which was earlier classified as a mid-cap fund and invested around 35% of its corpus in large-cap companies (until December 2017) is at par with DSP BlackRock Equity Opportunities Fund that invested 70% of its corpus in large caps. When seen from the new angle—large and mid-cap fund, the value of large cap holding of the former by end of May 2018 is 48% and that of latter is 63% in the same period.
The weightage average market cap of funds in this category varies significantly. If HDFC Growth Opportunities – the regular plan has a weightage average market cap of INR 1,88,152 crore, which makes it the largest in the category, then Essel Large & Midcap – Regular plan has weightage average market cap of only INR 16,307 crore, which makes it the smallest player in the category. This creates a confusion in the category, which will take time to clear.
You should, therefore, try to shun this category for now, and instead focus on multi-cap funds, which is similar to the newly launched fund category in each aspect but two:
- Large and mid-cap funds need to invest at least 35% each of its total net asset in the large cap as well as mid-cap companies.
- Multi-cap funds can invest in small cap companies.
Why Invest in Multi-cap Equity Mutual Fund?
- A multi-cap fund can invest in companies of all shapes and sizes. Large-cap funds need to stick to its large-cap portfolio, mid-cap funds are confined to the companies ranking from 101st to 250th by market cap, small cap funds can invest only in smaller companies (ranking 251st or below by market capitalization).
- By investing in large caps, it offers stability in the bear market when mid cap and small cap stocks fall.
- By investing in mid and small cap companies, this fund offers an opportunity for quick capital appreciation when bull runs on its course.
- It gives an all-round protection to investors. In a bearish market, large-cap will hold the forte when mid and small-cap loses extra fat, and when the economy is strong, mid and small cap portion of your fund will ride the bull and multiply your capital.
- It is a better way to create wealth in the long run. If given enough time, it offers returns comparable to that of a mid-cap fund, but with significantly lower volatility.
- A multi-cap fund safeguards your investment in any market condition.
- It is best suited for new investors as well as investors with a small portfolio.
Under the equity mutual fund, there are sectoral/thematic funds as well, which are designed to leverage the growth potential of a particular sector/theme. You may want to consider it, but it is not advised to put most of your money in such funds. A new investor may not be able to read and understand a sector fully, so it could be a good strategy to allocate just a small amount to a sectoral/thematic fund. ELSS is another sub-category under equity mutual fund, which you should consider when you need to get a tax benefit under Section 80C of the Income Tax Act. It has a statutory lock-in period of 3 years, which works as a damper for many investors. The return of ELSS tends to be lower in comparison to other equity mutual fund schemes.
In equity mutual fund category, multi-cap funds look more lucrative because it gives a decent return without exposing the entire investment to the market volatility by investing in the small-cap fund and mid-cap fund alone. For an investor who wants to stay invested for long-term, small-cap fund and the mid-cap fund can do magic over considerable time. They can create wealth like no other funds, but one should never remove the safety harness when flying, so one should have a large-cap fund in the portfolio as well. A long-term investor would be better off with an equity mutual fund. It will improve their chances of wealth creation, and when funds are given enough time, the risk involved is significantly reduced.
Note: While investing, do not spread your resources too thin. Choose one or two quality funds (maximum three) and start putting your money in those funds until you have accumulated a good amount. Do not worry about diversification. It has already been taken care of by mutual funds.