Does Investing in Mid and Small Cap Stocks Provide a Better Return Over Time?

Posted on by WealthDesk
Do Mid and Small Cap Stocks have Long-Term Benefits? | WealthDesk

In this Article

The face of the Indian stock markets has changed considerably in the wake of the pandemic. Mid-cap stocks and small-cap stocks have especially booked stellar returns for their investors since the market rally towards the end of March 2020. Several mid-cap and small-cap stocks outperformed their large-cap peers and recorded new record highs during the past one and a half years.

The inherent nature of the three types of funds, i.e., large-cap, mid-cap, and small-cap, has a huge correlation with the current winds of the stock market. Here is a rundown of why mid-cap and small-cap funds are designed to perform better when an investor decides to stay invested in the same over a period of time.

What Is a Mid-Cap Fund?

A mid-cap fund is a scheme that invests in equity or equity-related instruments of only mid-cap companies. SEBI defines mid-cap companies based on their market capitalization. According to the SEBI rules, all companies ranking between 101 and 250 in the list fall under the mid-cap category.

Reasons Why Mid-Cap Funds Are Good Investments:

Good mid-cap stocks provide the best of both worlds to an investor since they are less risky compared to small-caps and generate better returns than large-caps. This enables investors to reap the best risk-return ratio on their investments. Here are our two cents on why mid-cap stocks perform better over a longer time horizon and are a must in your portfolio:

Profitability:

Seasoned management teams, a profitable business, and higher earnings growth are all telltale signs of a good mid-cap fund. Companies that report higher gross and operating margins as well as enjoy a quick inventory and receivables cycle are bound to lead to higher profits. 

Growth:

 Mid-caps reporting not just higher revenues but also registering higher earnings growth potential for its investors should be sought. This in itself will turn any mid-cap company into a large-cap one gradually.

Financial Health:

A strong balance sheet that points at a comfortable debt position of a mid-cap company is another important indicator of a good return for their investors.

What Is a Small-Cap Fund?

A small-cap fund is a scheme that invests in equity or equity-related instruments of only small-cap companies. According to SEBI, all companies falling below the ranking of 250 in terms of market capitalization and having a turnover of less than Rs 500 crores are small-cap companies.

Reasons Why Small-Cap Funds Are Good Investments:

The best small-cap stocks are high return generating investments but come with a higher risk factor attached with them. However, an investment over a long period of time considerably mitigates the risk quotient, provided the companies are cautiously selected. Here are some reasons which make small-caps a good investment decision over a long-term horizon:

Potential to Create Wealth:

Small-cap funds have outperformed their benchmark indices in the recent past. With the potential to turn into large-cap and mid-cap funds of tomorrow, an investor with a decent risk appetite should definitely include small-cap funds in their portfolio.

Diversification:

Small-cap funds invest in emerging businesses of promising companies, which show potential to scale up in the future. They provide investors an exposure to niche segments such as sugar, textiles, construction, chemicals, etc., which leads to a well-diversified portfolio and spreading of risks.

How Mid-cap and Small-cap Funds Perform in the Long Term?

Both small and mid cap stocks in India perform well during times of economic recovery and benefit their investors from any inflation-related downturns. In line with this, as the economy revives and the government rolls out plans to support growth and infuse liquidity, both small cap and mid cap funds are set to record new highs. Well-placed companies backed by good management under these two categories have proved their resilience during the pandemic and generated good returns for their investors.

Mid-cap investors made twice the money that of large-cap investors in the last 17 months, while small-cap investors have been three times better than large-cap investors. (as of August 2021)

With an average return of 70% over one year in the mid-cap mutual fund category and a return of 114% recorded in the NIFTY small-cap 100, both these segments have proved their mettle as beneficial long-term investments.

However, investors should remain cautious and opt for an optimum mix of mid-cap and small-cap funds. They need to pay close attention to the financials of these companies and ensure a lower expense ratio in order to maximize the returns generated. Also, every investor comes with a different risk profile and wants to stay invested for different time horizons. Keeping this in mind, the exposure in mid-cap funds can be anywhere between 15-30% and 5-20% in small-cap funds. Lastly, every investor should review their asset allocation on a quarterly basis. The best way to do this is to get in touch with a wealth manager or a professional financial adviser who can provide the best guidance.

With WealthBaskets, you can invest in a basket of stocks and ETFs based on a theme, sector or idea. The WealthBaskets are created and monitored by leading SEBI registered experts. You get the stocks in your own demat accounts and receive dividends.

FAQs

Which is better: mid-cap or small-cap?

Mid-cap stocks are less risky as compared to small-cap funds but generate lesser returns than small-cap funds. There is no right or wrong answer. The desired asset allocation depends upon factors such as the risk appetite of the investor, time horizon, and customer profile.

Is it a good time to invest in small-cap funds?

Small-cap funds are a good investment choice if you have a decent risk appetite and want to stay invested for the long term. Also, the revival in economic growth post-pandemic shows an upward trend for the small-cap funds.

Why do small-cap stocks have higher returns?

Small-cap companies are risk-takers and can take advantage of current market trends to tweak their strategies. Due to this, they are in a better position to earn a higher return on investment (ROI) than their large-cap or mid-cap peers.