SEBI's 2017 categorisation exercise was meant to end the confusion of fund houses running six near-identical schemes under different names. It largely succeeded — but it left investors with a long list of official categories and no obvious guide to which matter.
The good news: you need to understand about seven.
How SEBI defines the equity universe
Companies are ranked by full market capitalisation, and the boundaries are fixed rather than judgement-based:
- Large cap — ranks 1 to 100
- Mid cap — ranks 101 to 250
- Small cap — rank 251 onwards
The list is revised twice a year, so a company can migrate between buckets.
The categories that matter
Large cap funds must hold at least 80% in the top 100 companies. Established businesses, lower volatility, and the least dramatic falls in a downturn. The trade-off: this is the hardest segment for active managers to beat, because the top 100 stocks are so heavily researched that genuine information advantage is rare. Most large cap funds underperform their index over long periods after fees — which is the strongest argument for using an index fund here instead.
Mid cap funds hold at least 65% in ranks 101-250. Companies that have proved their model and are scaling. Higher growth potential, meaningfully higher volatility — drawdowns of 40-50% in bad years are normal. Active management adds more value here, because coverage is thinner.
Small cap funds hold at least 65% in rank 251 and below. The highest potential return and the highest risk, with liquidity constraints that bite in a falling market — funds can struggle to exit positions without moving the price. Only for horizons beyond seven years, and only as a limited portion of the portfolio.
Flexi cap funds may invest across all three bands with no fixed allocation, at the manager's discretion. This is the most sensible single-fund core for most investors — one fund, full market exposure, and a professional deciding where the balance sits.
Multi cap funds are frequently confused with flexi cap. The difference is a hard rule: a multi cap fund must hold at least 25% in each of large, mid and small cap. That forces mid and small cap exposure even when the manager would rather not, which makes it structurally more aggressive than flexi cap.
ELSS funds are equity funds with a three-year lock-in that qualify for Section 80C deduction under the old tax regime. The shortest lock-in of any 80C instrument.
Index funds and ETFs track an index passively. Expense ratios are a fraction of active funds, there is no fund manager risk, and no chance of underperforming the index by much. Given how few large cap funds beat their benchmark consistently, an index fund is a defensible core holding.
Hybrid funds, in one paragraph each
Aggressive hybrid — 65-80% equity, the rest debt. Equity taxation with a built-in cushion. A reasonable single-fund option for cautious first-time investors.
Balanced advantage / dynamic asset allocation — the equity-debt mix moves with market valuations, rising when markets are cheap and falling when they are expensive. Useful for investors who want equity exposure but find volatility hard to sit through.
Conservative hybrid — 10-25% equity, the rest debt. For horizons of three to five years.
Debt funds worth knowing
- Liquid funds — maturity up to 91 days. Emergency corpus and very short-term parking.
- Ultra short and low duration — three to twelve months. Slightly better return, marginally more risk.
- Short duration — one to three years. Reasonable for goals in that window.
- Corporate bond funds — at least 80% in high-rated corporate paper. Better yields, with credit risk to assess.
- Gilt funds — government securities only. No credit risk, but significant interest-rate sensitivity; they can fall when rates rise.
Building the portfolio
You do not need one fund from each category. Three to five funds cover almost every investor's needs.
Conservative, or just starting out: 70% index or flexi cap, 30% aggressive hybrid.
Moderate, 10+ year horizon: 50% flexi cap or index, 30% mid cap, 20% small cap.
Aggressive, 15+ year horizon, comfortable with drawdowns: 40% flexi cap, 30% mid cap, 20% small cap, 10% international.
The most common portfolio error is not picking the wrong category — it is owning twelve funds that all hold Reliance, HDFC Bank and Infosys as their top positions. Check the portfolio overlap between your funds. Above roughly 50% overlap, you are paying two management fees for one exposure.
How equity fund gains are taxed
- Held under 12 months — short-term capital gains, taxed at 20%.
- Held over 12 months — long-term capital gains, taxed at 12.5% on gains above ₹1.25 lakh in a financial year.
Debt funds purchased after 1 April 2023 are taxed at your slab rate regardless of holding period.
Choosing within a category
Once you have decided the category, compare on these rather than last year's return:
- Rolling returns over 5-7 years, not point-to-point. Point-to-point returns are an accident of start and end dates.
- Downside capture — how the fund behaved in 2008, 2020 and 2022. Losing less matters more than gaining more.
- Expense ratio. Always choose the direct plan; the difference compounds to a substantial sum over decades.
- Fund manager tenure. A stellar ten-year record is not meaningful if the manager arrived last year.
- AUM. Very large small cap funds face real difficulty deploying money without moving prices.
Fund selection depends on your goals, horizon and tax position. Book a free consultation to review your current holdings.
