Fair Peer Groups: Why Comparing a Small Cap Fund to a Large Cap Fund Is Not a Real Comparison

“Fund A returned more than Fund B, so it’s the better fund”

That comparison only means something if Fund A and Fund B took on a similar kind of risk to get there. A SEBI category exists precisely to group funds that share a mandate - Large Cap, Small Cap, Value, and so on - so that returns within a category can be compared fairly. Compare across categories and you are really comparing market segments, not skill.

Average 3-year CAGR, by category

Small Cap Fund funds averaged 22.92% over three years, against 14.81% for Large Cap Fund funds - a gap of 8.11 percentage points. That gap says almost nothing about which category’s managers are more skilled. It mostly reflects which part of the market, small caps or large caps, happened to perform better over this particular three-year stretch. Small and mid cap stocks carry more volatility than large caps, and that extra risk shows up as both higher average return and a wider range of outcomes across this window. A below-average Large Cap Fund fund and an average Small Cap Fund fund can show similar raw CAGR purely because of which segment they sit in, with no useful read on manager skill either way.

What a fair comparison actually looks like

The right question is never “did Fund A beat Fund B” in isolation. It is “did Fund A beat the typical fund in its own category” and “did Fund B beat the typical fund in its own category.” Two funds can both be excellent, or both be mediocre, relative to their own peers, even while one’s raw return number is much higher than the other’s simply because of category. This is exactly what category rank and percentile and the category median are built to answer, by comparing a fund only against others in the same mandate.

Where this mistake is most common

• “Top performing fund” lists that rank across every category by raw return, with no adjustment, routinely put small and mid cap funds at the top simply because that segment had a strong run, not because those specific funds’ managers outperformed their own peers.
• Marketing material that quotes a fund’s return without stating its category or without comparing it to a category benchmark.
• Casual comparisons between, say, a flexi cap fund someone already owns and a small cap fund a friend recommends, without checking whether either beats its own category.

Frequently asked questions

Can I ever compare funds across categories?

You can compare their category-relative performance - did each beat its own peers - even when you cannot usefully compare their raw returns to each other. A top-quartile large cap fund and a middling small cap fund are not equally good just because their raw numbers look similar, nor are they directly comparable on raw return alone.

Why do small and mid cap categories show higher average returns here?

Smaller companies generally carry more growth potential and more volatility than large, established ones. Over a given window one segment can outperform the other for reasons unrelated to any individual fund’s manager, which is exactly why a fair comparison stays within category.

What if a fund changes category?

Its historical rankings and category comparisons before the change were computed against its old peer group, and after the change against the new one. Treat the two periods as not directly comparable to each other.