Small Cap Funds: A guide to Small Cap Mutual Funds

Last Updated: 30 Jun 2022

Small-cap companies, do not have any set definition. However, there are some accepted definition of small cap companies. Typically a company that has a market capitalisation of less than Rs.5,000 crore is normally classified as a small cap company. Funds that are dedicated to investing in such small cap companies are called small cap funds.

However, SEBI in its classification logic for mutual funds has given a ranking based definition of small cap funds. As per the new definition, applicable from 2018, all stocks will be indexed descending on market cap. The top 100 stocks will be classified as large cap stocks. The 101st to the 250th stock will be classified as mid-cap stocks and the stocks beyond the rank of 251 will rank as small cap stocks. A small cap fund has to mandatorily invest 85% of its corpus in these small cap stocks.

What are some of the typical features of Small Cap Funds

• Small cap funds invest predominantly in small cap stocks with a very small portion invested in higher market cap categories.
• Liquidity is a major challenge for small cap funds. It is tough be able to find small cap stocks in the numbers and volumes that funds require.
• Many small cap funds in the past have been forced to stop fresh inflows to avoid falling short of choice of small caps to invest in.
• Small cap stocks are typically focused companies with a single line of business and little diversification in the core business.
• Small cap stocks are riskier compared to the mid-caps and the large caps and their price movements can be quite volatile.
• Small caps typically outperform large cap funds over a longer period of time due to stocks in their portfolio having a higher growth potential.

How many small cap funds are there in India and who are the best performers?

Small caps have grown in size and today the small cap funds put together have a combined Asset Under Management (AUM) of nearly Rs.99,000 crore. These funds have been ranked based on their performance since inception. As can be seen, the lowest return of a small cap fund since inception is 14.56% on CAGR basis while the maximum returns are above 55%.

Scheme Name	NAV Direct	Return 1 Year (%) Direct	Return Since Launch Direct	Daily AUM (Cr.)
IDFC Emerging Businesses Fund	22.41	56.17	55.62	1,356.15
Principal Small Cap Fund	25.04	80.66	42.07	522.89
BOI AXA Small Cap Fund	27.67	75.13	40.52	203.57
Edelweiss Small Cap Fund	25.32	74.02	38.16	1,116.48
Canara Robeco Small Cap Fund	23.72	78.48	35.37	1,851.01
Tata Small Cap Fund	22.61	77.25	29.97	1,781.48
Invesco India Smallcap Fund	22.19	68.75	28.81	1,243.35
SBI Small Cap Fund	113.50	52.47	27.45	10,920.65
Nippon India Small Cap	90.99	77.53	26.52	18,013.83
ITI Small Cap Fund	15.42	41.00	26.44	407.13
Axis Small Cap Fund	66.32	62.19	26.43	7,694.69
DSP Small Cap Fund	116.15	61.92	23.33	8,496.00
L&T Emerging Businesses Fund	47.82	79.63	22.80	7,829.81
Kotak Small Cap Fund	183.79	78.61	22.15	6,519.51
Franklin India Smaller Companies Fund	97.74	60.28	21.35	7,108.91
HDFC Small Cap Fund	80.84	70.62	19.85	13,160.99
HSBC Small Cap Equity Fund	97.44	70.13	18.66	340.29
Sundaram Small Cap Fund	156.43	65.73	18.33	1,540.26
Aditya Birla Sun Life Small Cap Fund	59.22	57.11	18.02	2,896.91
ICICI Prudential Smallcap Fund	53.58	66.40	17.73	3,317.85
Quant Small Cap Fund	133.64	95.74	16.46	1,355.78
Union Small Cap Fund	30.26	63.83	15.82	571.56
IDBI Small Cap Fund	18.45	69.11	14.56	132.04

Data Source: AMFI

Almost all the small cap funds have done extremely well and have specifically done better than the large cap funds on an average.

What are the advantages of investing in small cap funds?

Here are some of the benefits of investing in small cap funds in India.

1. You have the potential to earn high returns and better the large cap funds by a huge margin. Small cap funds invest in smaller companies with substantial growth potential. We have seen in the past how companies like Britannia, Lupin and Titan went from being small caps to large caps creating billions of wealth in the process. In the future, such smaller companies could become mid-cap or large-cap companies. In short, the returns potential is very high in small-cap funds.
2. Most of the small cap stocks are avoided by large institutions due to lack of liquidity. This allows the stock to move on the strength of its own merits. So, the chances of organic price rise are higher in such companies.
3. In portfolios dominated by large cap and index companies, these small cap stocks offer the much needed Diversification of risk. These small cap funds invest your money in companies from different industrial sectors like IT, banking/financial, automotive, FMCG, and more. Also, small cap stocks tend to less correlated to the index stocks, making them a better diversification bet.

Check list of facts to know about small cap funds

A small-cap fund does possess excellent potential to grow and deliver above market returns. However, there are a few things that an investor should know before investing.

• Like it or not, but these small cap funds can highly risky and volatile. Since these funds mostly invest in small-cap companies, they tend to be riskier and also more volatile. The NAV can fluctuate wildly during bear markets or during times of uncertainty.
• Liquidity is a big challenge so your allocation to small cap funds should be a small part of your allocation to equity funds. This would ensure that the balance is maintained and you don’t get overexposed to small cap risk.
• Small cap funds are more suitable to Long-Term Investors. Most small companies take a lot of time to witness significant growth and achieve economies of scale. So, these funds are mostly ideal for long-term investors with a perspective of 5=7 years at least.
• Fund Composition is nothing but the portfolio of the fund, which his there for you in the fact sheet. While it is essential to check the portfolio of any fund you invest in, it is more critical in case of small cap funds. Investors must make it a point to check the composition of the fund thoroughly before making a decision. Past performance can be a good barometer in this case.

How do I know if small cap funds are suited to me?

There are 4 ground rules to follow to answer this question.

• These small cap funds are suited to aggressive investors with a long-term investment horizon only. Small cap funds also call for higher risk appetite
• Small cap funds are best suited to investors with an appetite for portfolio value fluctuations and hence it is best to have only a small exposure to small cap funds
• More than investing in lumpsum, these small cap funds are ideal if you are investing via systematic investment plans or SIPs. Here the rupee cost averaging works in your favour and reduces your cost of holding.
• Finally, ensure that these small cap funds are not more than 10-15% of your equity exposure and they actually fit into your long term goals. That is the real acid test for small cap funds.