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Different agencies define large, medium or small cap, according to their own methodology. Understand them better...

We humans find comfort in classification and segmentation.

That is why many of us prefer the well-demarcated aisles in supermarkets, rather than popping into the local grocer's cluttered store. We extend the same desire to investing and consider it especially important when there are over 4,000 listed stocks and hundreds of mutual fund (MF) schemes.

A common method of classification is the market capitalisation (MC)-based method, wherein stocks/funds are divided into large-cap, mid-cap and smallcap. MC is the product of the market price and the number of equity shares outstanding. It may be computed either on a total or afree-float basis. Many investors have a clear preference regarding the category they would like to invest. While some stick to largecaps, others gravitate towards midcap and small-cap stocks.

However, their definition varies widely. For instance, the Bombay Stock Exchange (BSE) considers stocks falling within the first 80 per cent of the free-float market capitalisation as large-caps and those within 80-95 per cent as midcaps while computing their indices. The National Stock Exchange (NSE) considers stocks falling within 75 per cent and 95 per cent of the free-float market capitalisation as part of the eligible universe, while computing the NSE MidCap Index.

Even mutual funds differ markedly. For instance, Birla Mid-Cap Fund uses an absolute filter of stocks with a market-cap between `150 crore and `1,500 crore. DSP Micro Cap's universe constitutes of stocks that are not part of the top 300 companies by market capitalisation. What constitutes small-cap for some may be micro-cap for another.

Here's some solution to the segmentation conundrum:

Strike a balance: Rather than obsessing over the the classifications, investors could opt for clear options within each category. For instance, Hindustan Unilever and Jyothy Laboratories are large and mid-cap stocks, respectively, by most definitions. Owning both will give investors an exposure to two good companies across the market-cap spectrum. If you prefer mutual funds, choose 'goanywhere' funds, which operate without any market-cap bias. However, even in these, the fund's philosophy will lead to a tilt in some direction. Fidelity Equity Fund, for example, is primarily large-cap oriented, while Reliance Regular Savings is mid-cap oriented, though both profess to be market-cap agnostic. Choose the one whose style you are comfortable with.

Choose Index Funds/ETFs:

These mirror specified large and mid-cap indices and offer a low cost option to gaining exposure to a variety of stocks at one go. In fact, undertaking monthly SIPs in one Nifty/Sensex-related exchange traded fund (ETF) (example Benchmark NiftyBeES or Franklin Index Fund – Sensex) and one mid-cap ETF (say Benchmark Junior BeES or MOST Midcap ETF) could be good enough. Any change in the underlying index's composition automatically leads to a rebalancing of your holding. There is also no fund manager-related risk.

Choose appropriate funds: Ensure the large or mid-cap fund you are investing in is true to its mandate. For instance, Franklin Bluechip strictly ensures over 80 per cent of its corpus is invested in largecap stocks and, hence, is a good fund for those seeking a largecap fund. Funds which frequently modify their mandate end up confusing and disappointing investors.

Be cognisant of biases: Often, the preference for one category over the other may be due to 'recency bias'. If stocks or indices belonging to a certain category outperform for some time, investors gravitate towards that class. For instance, mid-cap indices outperformed large-cap indices for a large part of 2010. This led to heightened interest for mid-cap stocks. Similarly, during the market correction of 2008, large and well-known companies fell less than the rest, thereby creating an illusion of safety, leading to a penchant for large-caps.

Happy Investing!!

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