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Why company size matters for your portfolio

Your portfolio may tilt too much towards riskier small companies or relatively safe large companies. But balance is the key

Why company size matters for your portfolio

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Large companies are inherently different from small ones, and this is something that investors appreciate far less than they should. We tend to be more aware of sectors and industries, and less of company size. And yet, the fact is that while a large auto company will have some things in common with a small auto company, it will also have some things in common with any other large company. These size-based characteristics will not be shared by even small companies in its own sector.

Likewise, small companies are similar to other small companies in terms of how they operate, their growth potential, and so on. A smaller entity can grow faster, or decline faster. It can take advantage of a changed business situation better and grow rapidly, or be unable to cope with changes and decline rapidly. Something similar happens at the level of their price movements in the stock markets. A mid-cap company will typically (though not always) have a relatively low trading volume and a smaller number of traders - large or small - interested in it. This means that any given piece of news, positive or negative, can affect its stock price much more sharply than it would a large-cap stock. It also means that much less research attention is paid to these stocks. The said good news may just as easily have no impact on the stock price. Investing in small- and mid-cap companies boils down to higher potential gains, and higher potential losses. In other words, returns with risk. There's another factor at work here, which is that of variance. Large companies tend to be alike, but the variance in smaller companies is much greater.

So how do you as an investor then approach market capitalisation? Even if you have figured out how much of your equity portfolio should be invested in different sized companies based on your risk appetite, you need to ensure that it remains in this proportion. Like other types of diversification, an imbalance in capitalisation can sneak up on fund as well as stock investors without them realising it. Some of your funds may be mid-cap or multi-cap funds. Given similar market conditions, a number of fund managers might shift more towards smaller companies and before you know it, your entire portfolio may tilt too much towards riskier companies.

To stay on top of the capitalisation break-up of your portfolio, the Portfolio Manager on ValueResearchOnline.com has a simple tool. On the 'Analysis' view of the 'My Portfolio' section, there's a small table titled 'Portfolio Style Break Up'. Here, you can discover how much of your money is deployed in companies of different sizes.

Why company size matters for your portfolio