In 2024, the best small-cap fund returned 46%. The worst? Around 14%. Same category. Same time period. A gap of over 30 percentage points.
But here's what most articles won't tell you: that same year, the average large-cap fund returned just 15%. Even the best large-cap fund couldn't match an average small-cap performer.
So which matters more – choosing the right category or picking the right fund within it?
At Belong, we talk to NRIs daily who get stuck on this question. They spend weeks comparing expense ratios between two large-cap funds while ignoring whether large-cap is even the right category for their 15-year retirement goal.
Or they chase small-cap returns without understanding why that category might destroy their sleep for years.
This guide settles the debate with actual data. Not opinions. Not marketing speak. Just facts that will change how you build your mutual fund portfolio.
The Numbers That Changed How I Think About Fund Selection
Let me share something that surprised me when I first analysed it.
The famous Brinson, Hood and Beebower study from 1986 claimed that asset allocation explains 93.6% of portfolio return variation.
Financial advisors worldwide have used this to argue that category selection is almost everything.
But that's a misreading of the research.
What the study actually showed was that asset allocation explains the variation in returns over time for a single portfolio. When Ibbotson and Kaplan revisited this in 2000, they found that asset allocation explains about 40% of the return difference between different portfolios.
What does this mean practically?
If your portfolio returns 5% more than mine over 10 years, roughly 2% of that difference (40% of 5%) comes from our different category allocations. The remaining 3% comes from which specific funds we picked, our costs, and timing.
Both matter. But they matter differently at different stages of your decision.
Why Category Selection Is Your First Decision
Before you compare HDFC Mid Cap Fund to Kotak Emerging Equity Fund, you need to answer a more basic question: Should you even be in mid-caps?
The Category Return Gap Is Real
Look at the long-term category averages:
Category | 10-Year Average Returns | Typical Volatility |
|---|---|---|
Large Cap | 10-12% | Lower |
Mid Cap | 12-16% | Moderate |
Small Cap | 15-20%+ | Higher |
[Source: Value Research, Historical Category Data]
The difference between large-cap and small-cap categories over 10 years can be 5-8% annually. On a Rs 50 lakh investment over 15 years, that's the difference between Rs 2 crore and Rs 3.5 crore.
No amount of fund selection within large-cap can overcome choosing the wrong category for your goal and timeline.
👉 Tip: Match your category to your time horizon. Small caps need 7+ years. Mid caps need 5+ years. Only then does their higher volatility translate to higher returns.
SEBI's Categorization Made This Simpler
In 2017-2018, SEBI standardized mutual fund categories. Clear definitions now exist:
Large Cap: Top 100 companies by market capitalization
Mid Cap: Companies ranked 101 to 250
Small Cap: Companies ranked 251 and below
A large-cap fund must invest at least 80% in large-cap stocks. A mid-cap fund must maintain at least 65% in mid-cap stocks. This standardization means your category choice actually delivers what it promises.
Before 2018, a "large-cap" fund could secretly hold 40% mid-caps to boost returns. That gaming is now difficult.
Why Individual Fund Selection Still Matters (A Lot)
Here's where it gets interesting.
Within the same category, performance dispersion is massive. In 2024, Business Standard reported these category gaps:
Small Cap Funds (2024):
- Top performer (Motilal Oswal Small Cap): 46.0%
- Category average: 15.2%
- Bottom performers: Single digits
Large Cap Funds (2024):
- Top performers (ICICI Pru Bluechip, Kotak Bluechip): 16.9%
- Category average: 15.2%
- Laggards: Around 9%
Notice something? In large caps, the top-to-bottom gap was about 7%. In small caps, it exceeded 30%.
This tells us: Fund selection matters more in riskier categories.
The Quartile Difference
Fund performance is often measured in quartiles – dividing all funds in a category into four groups based on returns.
Research shows that the difference between top quartile and bottom quartile funds within the same category can be 5-8% annually over longer periods.
If you're in the right category but wrong fund, you leave significant returns on the table.
👉 Tip: Use Belong's Mutual Funds Explorer to compare funds within the same category based on rolling returns, not just point-to-point returns. Rolling returns show consistency that point-to-point returns hide.
The Hierarchy: Get This Right First
After analysing thousands of NRI portfolios, here's the framework we use at Belong:
Step 1: Choose Your Asset Allocation (Most Important)
How much in equity vs debt vs alternatives?
This decision alone determines 40% of your return variance. A 70-30 equity-debt split will behave completely differently from a 90-10 split.
For NRIs with repatriable investments, this also affects tax planning and exit flexibility.
Step 2: Choose Your Category Mix Within Equity
Once you've decided on, say, 70% equity allocation, how do you split it?
- 50% large cap for stability?
- 30% mid cap for growth?
- 20% small cap for aggressive growth?
This is where your investment horizon, risk tolerance, and goals matter most.
Step 3: Select Individual Funds Within Each Category
Only after the above two steps should you compare HDFC Mid Cap vs Kotak Emerging Equity vs Axis Midcap.
At this stage, you're optimizing within a decided framework – not making foundational decisions.
How to Choose the Right Category for Your Goals
Different goals need different categories. Here's a practical mapping:
For Retirement (10-15+ Years Away)
You can afford volatility. Growth categories make sense.
Suggested mix:
- 40-50% Large & Mid Cap or Flexi Cap for core stability
- 25-30% Mid Cap for growth
- 15-20% Small Cap if you can handle volatility
- 10-15% International exposure through GIFT City funds
Funds like DSP Global Equity Fund or Tata India Dynamic Equity Fund can add diversification.
For Children's Education (7-10 Years)
Moderate risk with some growth orientation.
Suggested mix:
- 50-60% Large Cap or Large & Mid Cap
- 20-30% Flexi Cap
- 10-20% Hybrid Funds for stability
For Near-Term Goals (3-5 Years)
Capital preservation matters more than growth.
Suggested mix:
- 60-70% Large Cap or Balanced Advantage Funds
- 20-30% Debt funds
- Consider GIFT City FDs for guaranteed returns
👉 Tip: Don't know your risk profile? Use Belong's Compliance Compass to understand what investment categories suit your situation.
How to Select the Right Fund Within a Category
Once you've chosen a category, here's how to pick the best fund:
Check Rolling Returns, Not Just Point-to-Point
Point-to-point returns can mislead. A fund might show 18% 5-year returns because it had one exceptional year.
Rolling returns tell you what returns the fund delivered across hundreds of overlapping periods. This shows consistency.
Look for:
- Average 3-year rolling returns higher than category average
- Minimum rolling returns not too negative
- Consistent quartile rankings over multiple years
Compare Against Benchmark, Not Just Peers
A fund that beats other funds but trails its benchmark is still underperforming.
For large-cap, compare against Nifty 100 TRI. For mid-cap, use Nifty Midcap 150 TRI. For small-cap, use Nifty Smallcap 250 TRI.
Check Expense Ratio Within Category
Expense ratios eat into returns. But compare apples to apples.
A small-cap fund charging 1.8% might be reasonable (more research needed). A large-cap index fund charging 1.5% is expensive (should be under 0.5%).
Always compare direct plans. Regular vs direct can differ by 1% annually.
Look at Fund Manager Track Record
In categories where active management matters (mid-cap, small-cap), the fund manager's experience and tenure matter.
Has the manager handled the fund through a market cycle? Did they perform during both 2020's crash and 2021's rally?
Common Mistakes NRIs Make
Mistake 1: Choosing Category Based on Last Year's Returns
Small caps returned 47.5% in 2023, 29.3% in 2024, and then crashed about 7% in early 2025. [Source: Whalesbook]
Many NRIs piled into small caps after seeing 2023-24 returns. They experienced the 2025 crash and panicked.
The category wasn't wrong. The timing of entry and unrealistic expectations were wrong.
Mistake 2: Over-Diversifying Within the Same Category
I've seen portfolios with 5 different large-cap funds. That's not diversification – that's redundancy.
Most large-cap funds hold similar stocks (Reliance, TCS, HDFC Bank). Owning five doesn't reduce risk. It just adds complexity.
One or two funds per category is usually enough.
Mistake 3: Ignoring Category When Checking Fund Ratings
A 5-star small-cap fund is still riskier than a 3-star large-cap fund. Ratings compare within category, not across categories.
Don't assume 5 stars means "safe." It means "best in its risk category."
Mistake 4: Not Rebalancing Category Allocation
If small caps rally 40% and large caps gain 15%, your portfolio shifts toward small caps automatically. What was a 20% small-cap allocation might become 30%.
This drift increases risk. Annual rebalancing brings it back to your target allocation.
👉 Tip: Set calendar reminders for annual portfolio reviews. Or use Belong's app to track your allocations automatically.
The GIFT City Advantage for NRIs
Here's something specific to NRIs that changes the category calculation:
Investments through GIFT City IFSC enjoy significant tax benefits. For NRIs who retain non-resident status, long-term capital gains from GIFT City mutual funds can be tax-free under specific conditions.
This means your effective post-tax returns improve across all categories. A 12% pre-tax return that would become 10.5% after standard capital gains tax becomes the full 12% through GIFT City.
When comparing categories, factor in this tax efficiency. The after-tax gap between large-cap and small-cap narrows when both benefit from GIFT City's tax advantages.
Explore GIFT City mutual funds through Belong. No NRE/NRO account needed. No capital gains tax for NRIs.
A Simple Framework to Decide
Still confused? Here's a decision tree:
Question 1: What's your investment horizon?
- Less than 3 years → Mostly debt, some large-cap
- 3-7 years → Large-cap dominant, some mid-cap
- 7+ years → Can include significant mid and small-cap
Question 2: Can you handle 40% temporary declines?
- Yes → Small-cap allocation possible
- No → Stick to large-cap and balanced funds
Question 3: Do you need regular income from investments?
- Yes → Focus on dividend yield funds or SWPs
- No → Growth-oriented categories
Question 4: Is repatriation important?
- Yes → Ensure investments are through NRE account or GIFT City
- Flexible → NRO-based investments also work
Once categories are decided, use rolling returns and expense ratios to pick specific funds.
The Bottom Line
The category vs fund selection debate has a clear answer: Both matter, but in sequence.
Category selection sets your return potential and risk range. It's the strategic decision. Get this wrong, and no fund selection can save you.
Fund selection optimizes within that range. It's the tactical decision. Get this wrong, and you leave returns on the table but don't destroy your wealth.
For NRIs specifically:
- Start with your goals and timeline
- Match to appropriate categories
- Consider GIFT City for tax efficiency
- Then – and only then – compare individual funds
- Use rolling returns, not point-to-point, for comparison
The best fund in the wrong category will always underperform an average fund in the right category for your situation.
What to Do Next
Assess your goals: List your financial goals with timelines. Use our tools to understand your tax status.
Map goals to categories: Use the frameworks above to decide your category mix.
Compare FD rates as baseline: Check current NRI FD rates to understand your risk-free alternative.
Explore GIFT City options: For tax-efficient investing, check GIFT City funds.
Join our community: Many NRIs discuss exactly these portfolio decisions daily. Join our WhatsApp community for peer discussions and expert guidance.
Download the app: Get the Belong app to compare funds, track performance, and invest through GIFT City.
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