Small cap funds focus on the discovery of high growth companies that are likely to transform into tomorrow’s market leaders resulting in capital appreciation over the long term. As an investor you may have even heard of the terms ‘small-cap funds’, ‘mid-cap funds’, and ‘large-cap funds’. These types of mutual funds provided by asset management companies are characterised by their share market capitalization. Small-cap, mid-cap, or large-cap is not the size of the mutual fund. Here ‘cap’ or capitalisation is indicative of the size of the companies in which the mutual fund invests.
Small businesses are quite often referred to as the pillar of the Indian economy by the media, they exist in multiple sectors engaged primarily in retail, manufacturing, services, construction etc, In recent years, a wide range of schemes and opportunities were set forth by the government of India to encourage these small businesses, and there is a continuous push for modernisation and reinforcement of the economy. Hence, in the long run the share of small companies in the economic growth cycle is likely to increase. If you want to be part of the long term growth journey of young companies in India, some of which may develop to be tomorrow’s leaders or future large-caps then consider investing in a small cap fund.
These funds are very volatile in the short term so some experts recommended an investment horizon of 7 years or more. The small cap funds invest in companies having a market cap that is less than Rs 500 crores, hence a few positive news releases can take the share to new highs. This is a huge opportunity for you to earn good returns by investing in small cap mutual funds.
Small cap funds attempt to invest in companies that have scalable business models, are run by professional management and with an aim to generate high return on invested capital. While the upside of investing in a portfolio of small cap companies is their growth potential, they can be fairly volatile. Small cap fund schemes are very sensitive to stock market movements and may yield good returns during a positive market swing. However, this means that during negative stock market sentiment, or a bear market, these small cap funds will lose substantial value. Hence small-cap funds are placed at the higher end of the risk-return spectrum.
Most small cap schemes follow a predominantly small cap strategy with a minimum exposure of 65% to small cap stocks. These small cap funds may also seek participation in other equity and equity related securities to achieve the best portfolio composition. Small cap mutual funds are ideal for aggressive investors who seek greater returns and are comfortable with higher risk. These small cap funds are not for the faint hearted or conservative investors.
As a retail investor it is best not to try to time the share market, as it is risky and sometimes unreliable. Predicting the share market is also very difficult even for most economists. Any changes in the stock market will reflect in a change in the fund’s net asset value (NAV). When the market as a whole is not performing well, smallcap type of mutual funds tend to have negative returns. In times of stock market instability, smaller and less established companies may also go out of business. If you go wrong with your forecasts, it could lead to losses for your investments. Hence a better way is to only invest in small-cap mutual funds through a systematic investment plan (SIP). This way you will average out the cost of units over a market cycle, thus reducing volatility. Another technique is to diversify your portfolio so that your losses are minimal when the markets are low. A healthy mix of mutual funds will act as a safeguard against a big loss. You may even get good returns in other areas of your investment portfolio when small-cap funds fail to deliver profits.
The information, analysis and opinions expressed herein are for educational purposes only and are not intended to provide specific advice or recommendations for mutual fund schemes. This material is not an offer, solicitation or recommendation to purchase any financial products or services. Always remember that all investments carry some level of risk, including the potential loss of principal invested.
