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Regulators around the world have categorized companies by market caps and Mutual funds en-masse have designed products around market caps. The history of these definitions has been to protect the average investor. The intent of this was never wrong – however, with the passage of time, investors forget the intent and follow the outcome.

I believe we are at the juncture of one such outcome in the Indian Capital markets.

As a country evolves, the GDP and in turn the market cap goes through years of compounding. As an investor goes through this compounding, the definitions of market caps change over time.

Fig 1 : Large Cap cut off change over time. Today, the cut off on the lower end for the Large Cap is at 70,000 cr. To put this in perspective, it used to be 5,000 cr in 2005.

Source : AMFI, Ambit Research

Fig 2 : Mid Cap cut off change over time. Today, the cut off to enter a Mid cap in the Indian equity markets on the lower end is at 23,000 Cr. To put this in perspective, it used to be 1,000 Cr in 2005


Fig 3 : Small Cap Cut off Change over time. Today, the cut off to enter a Small Cap in the Indian equity markets on the lower end is at 7,000 Cr. This used to be at 400 cr in 2005.


It is important to now appreciate why the regulator set these limits. The governance, research coverage and liquidity was extremely low and the regulator had to protect the average investor through these classifications.

However, standing in 2023, every fund manager continues to discuss risk in the form of large caps, mid caps and small caps and the nomenclature and what we associate of them has not changed. While I am not writing this with an objective of changing this nomenclature, this is an attempt to discuss an alternate way to view the same.

As the Indian markets have evolved, so has the liquidity. Today, there are companies in the small cap space with better governance (though this is subjective) and more liquidity (measured in the form of Average Daily turn over) than some of the largest mid-caps in the country.

At Itus, we measure our risk through the lens of liquidity rather than the measure of market caps as we believe we are increasingly losing relevance of this measure. While it is important to appreciate that we are in the middle of a strong market and the next sell-off can cause distortions in these numbers, it is more relevant to look at the trend than to get caught up in the micro.

Can the regulator do something though?

Though it is not the job of the regulator to address this, the one thing the regulator can do is to create a second level of categorization like what has been done in the US. For eg : the small cap index in the US is a broad list of 3000 companies as defined by Russell. There are two sub-indices which distinguish where one measures the liquidity – Russell 1000 that has the largest 1000 companies of the small cap index and the Russell 2000 which has the largest 2000 companies of the 3000 indices.

The investor can distinguish between the two sub-components through measuring liquidity and risk.

To put this into numbers, the median market cap of Russell 2000 Index is at USD 0.77 bn which is lower than the lowest market cap cut off for the Small Cap index in India today. This is comparing two markets where India’s market cap is currently 1/10th that of the US.



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