Investment risks in small cap and mid-cap companies? Market cap of small, mid and large cap companies

Small-cap, mid-cap, and large-caps are listed companies categorised as per their market capitalisation. Market capitalisation is the sum of the current share price value of all the outstanding shares of the companies listed in the exchange. Small-cap companies have a market cap of Rs 5,000 crore or less, while mid-cap companies generally have a market cap between Rs 5,000 to 20,000 crores. Large caps are companies with a market cap of over Rs 20,000 crores. Since the beginning of the new financial year, we have seen small- and mid-cap indices outperforming large-caps. While large-caps saw a growth of 6.4%, small-caps registered a growth of 20% and mid-caps grew by 10%. 

This is not surprising, as large-caps are known for steady and reliable returns. Small-caps and mid-caps, on the other hand, are aspiring large-caps. So they continue to perform at a higher rate, even though they come with more risks. 

What are the risks associated with investment in small cap and mid-cap companies?
If you are impressed with the higher returns of mid- and small-cap companies and wish to invest in them, you have to consider some associated risks as well.

• Weak business fundamentals: When there is a positive sentiment in the market, small- and mid-caps rally higher as their ratings get readjusted and so they attract many investors. However, even companies with weak financials get drawn to this rally, creating the later possibility of a market correction of such stocks. An average investor stands to lose if they invest in a high-performing small- or mid-cap with feeble business fundamentals.
   
• Extent of exposure: While investing in small- and mid-caps, the extent of your exposure to such stocks is crucial. Even if the additional liquidity in these stocks drains out in the future, an investor doesn’t stand to lose a lot if the exposure is limited. 
   
• Cyclical pattern: Small- and mid-cap stocks have a shorter boom-and-bust cycle. So, investors must know when to enter or exit from these stocks. The current scenario also matters in determining the cycles. Opportunities may be more in sectors that were severely impacted by COVID-19, such as tourism, hospitality, and entertainment. 
   
• Benchmarking difficulty: Large-cap stocks can be benchmarked to indices like BSE and Nifty as they are representative of the market capitalisation. Small- and mid-cap indices may see some companies trading in the market capitalisation range similar to the indices, but it is difficult to benchmark them under a single h
• omogenous category.
   
• The need for research: Due to the risks involved and difficulty in benchmarking, investors should research small- and mid-cap stocks thoroughly before investing. Check their business fundamentals, possible vulnerabilities to uncertainties, and response to market movements. 

What’s the way out?

You can invest in small- and mid-caps through the SIP route to minimise timing risk. This protects you from sharp price movements that small- and mid-caps tend to go through. It also adds flexibility to your investment pattern. 

One other option that offers flexibility is a flexi-cap fund. Introduced last year by SEBI, flexi-caps offer small retail investors the opportunity to invest in promising stocks across all market caps. If you invest in these, you keep a presence in all the caps along with the expert watch of your fund manager. SEBI requires multi-cap funds to invest at least 25% in all three caps, but flexi-caps offer the flexibility to fund managers to invest in these three caps in any ratio.