September 29, 2020
Small, Mid & Large Caps explained – which is best to invest in?
The companies in a stock market are often divided into three main categories — large, mid (medium) and small — based on their market capitalization. Market cap, as it’s known, refers to a company’s value as calculated by multiplying its shares by its current share price.
The Differences amongst the Caps
There is no official set of numbers differentiating small, mid and large-cap companies, however there are commonly used guidelines. We’re going to break this down here, so when you hear or read about this jargon, it makes sense.
In the US, companies are often categorised into the following buckets based on their market cap:
Large cap – $10 billion +
Mid cap – $2 – $10 billion
Small cap – $250 million – $2 billion
In NZ, however, the scale is slightly different due to our market size. Companies over $1b tend to be viewed as large-cap. An example of this is Kernel’s NZ 20 fund, which is comprised of the 20 largest NZX listed companies. The NZ 20 would be considered a large-cap fund in the New Zealand market.
Companies below this $1B threshold tend to be grouped together as small and mid-cap. Enter the Kernel Small & Mid Cap Opportunities Fund.
Why Company Size Is Important
Performance can vary widely from large to small cap companies.
Large-cap, often referred to as ‘blue-chip’, companies are the most established and usually have multiple branches in their businesses. They’re considered a less risky investment than smaller companies.
Small-cap companies typically operate a more specialised line of business, or are still establishing their foothold in a market, and therefore could experience more dramatic swings in their performance and their stock prices.
At the same time, larger, companies can be more affected by what’s happening outside of NZ — variations in global currency exchange rates, international economic growth, and global trade deals. These typically won’t affect smaller companies to the same degree, given they tend to be domestically focused.
While all three categories generally move in the same direction, the extent can vary at any given time. As a general rule, smaller companies have more risk, but are also more likely to grow. Bigger companies are typically much more stable but may underperform their riskier, smaller peers.
Using the Right Mix in Your Portfolio
One thing to consider is your own personal level of risk tolerance and investment horizon. Everyone’s asset allocation for, and within, stocks is going to be different.
Fans of the Barefoot Investor may want to go all-in on large-cap stocks. Others may prefer a more balanced approach that stretches across companies of many sizes. There is no single rule that works for everyone. You have to understand your investment goals and build a portfolio strategy that makes sense for you.
Knowing how large, medium and small companies fit together can help you land the right mix. Sticking with a good plan for the long term is the best way to succeed in the stock market.
TIP: When the economy begins to emerge from recession and starts growing again, small-cap companies can respond to the positive environment quicker and potentially grow faster than large-caps.
Why choose small & mid-cap companies?
Most successful large-cap companies were at one time small businesses. Investing in small-caps gives you the chance to get in on the ground floor. These younger firms are bringing new products and services to the market or creating entirely new markets. And given their smaller size, they can grow in ways that is simply not possible for larger companies.
These companies also tend to have less coverage by research analysts and actively managed funds. In NZ, there aren’t many companies outside of the top 50 that are regularly researched by professionals or institutions.
The downside of this is that these companies may not get the investment they need to grow, or to help increase their share price. On the flipside, it can mean that there are opportunities to get into these companies at lower valuations, which can provider higher returns over the long term.
Reduce your risk, reap the rewards
While individual small and mid-cap stocks can be more volatile (risky) than large caps, the beauty of investing via an index fund is that you reduce this risk. you immediately diversify your investment across a basket of smaller companies.
Everyone talks about wanting to find the next Xero, A2 Milk or Pushpay, because these companies were once small caps. Had you possessed the foresight to invest in them from the beginning, even a modest commitment would have ballooned into a small fortune.
But rather than trying to pick these winners in advance, by owning a diversified index fund covering small and mid-cap companies, you can ensure that you will get your share of the return from any future rising star.
Remember, rewards don’t come without risks in investing.
The must-knows about the Kernel Small & Mid Cap Opportunities Fund:
Well diversified: The number of the companies in this index can vary over time, currently there are 43 companies in the index
Size is important: To be included in the index you can’t be in the S&P/NZX 20 Index, and the minimum market capitalisation has to be over $100m
Rebalancing frequency: Semi-annually
Range of sectors: As well as being diversified across a range of companies, this fund is well diversified across 11 different sectors including technology, healthcare and consumer staples
It’s not just growth: Not only does this fund provide capital growth, it also generates income. With a large holding in the real estate sector, this fund has an indicative yield of 4% p.a. (as at September 2020)
Ready to start investing? Invest across both small, mid- and large-cap New Zealand equities through Kernel.
Founder & Chief Executive