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Small Cap Funds: A Guide to Small Cap Mutual Fund

When classified based on market capitalisation, equity funds can be divided into large-cap, mid-cap, and small-cap funds. This post will focus on small-cap funds, their structure, benefits, and more. Keep reading.

Market capitalisation says a lot about a company. For instance, companies with large market caps of more than Rs. Thirty thousand crores are known to have stable finances with a strong market presence. From the investment point of view, stocks of large-cap companies are known to carry low risk. But, such companies have already achieved tremendous growth, and the future growth potential would in line with market expectations. So, while investing in such companies would mean lower risk, the returns potential is limited too.

On the other hand, small-cap companies with a market capitalisation of less than Rs. Five hundred crores have a lot of room for growth. These are generally smaller and often recently established companies that offer exceptional returns potential. But as they are small, and probably new too, chances of failure are high as well.

So, while such small-cap companies do have great potential, they also carry a significantly higher level of risk. The small-cap mutual funds try to take advantage of such companies. Here is a detailed guide on what is a small-cap fund , how it works, and its top benefits.

What are Small Cap Mutual Funds?

As discussed above, small-cap funds invest your money in stocks of companies that have a market capitalisation of less than Rs. 500 crores. On stock indices such as Sensex, small-cap companies are generally ones that are ranked below the 250th spot. These companies are usually young and small, and their focus is mostly on aggressive expansion.

By investing in them when their market cap is still small, the small-cap funds aim to benefit from their growth potential. In other words, as compared to large-cap and mid-cap funds, small-cap mutual funds have higher returns potential.

But in the expansion process, such companies are also highly vulnerable to losses. So, while such funds do offer excellent potential, the risk level is higher than large-cap and mid-cap funds. Most small-cap funds generally invest 65% to 90% of their portfolio in smaller companies.

Benefits of Investing in Small-Cap Mutual Funds

Now that you have a brief idea about what is small-cap mutual funds in India let us check out some of the reasons why investors prefer them

  • High Returns Potential-

    As discussed, these funds invest in smaller companies that have a lot of growth potential. In the future, such smaller companies could become mid-cap or large-cap companies. So, the returns potential is very high in small-cap funds.

  • Higher Probability of Organic Growth-

    Financial institutions are known to push the prices of stocks they have invested in artificially. But some regulations limit their investments in small-cap companies. So, the chances of organic price rise are higher in such companies.

  • Diversification-

    These mutual funds invest your money in companies from different industrial sectors like IT, banking/financial, automotive, FMCG, and more. This helps in adding a lot of diversification to your mutual fund portfolio.

Important Things to Know About Small-Cap Mutual Funds

While a small-cap fund does have excellent potential, there are a few things that an investor should know before investing.

  • Highly Risky and Volatile-

    As these funds mostly invest in small-cap companies, they are very risky and highly volatile. The NAV can fluctuate wildly during the bear markets.

  • Ideal for Long-Term Investors-

    Most small companies take a lot of time to witness significant growth. So, these funds are mostly ideal for long-term investors.

  • Fund Composition is Critical-

    A small-cap fund is only as good as its portfolio. So, check the composition of the fund thoroughly before making a decision. Prefer funds from reputed fund houses that have highly experienced fund managers.

Who Should Invest in Small-Cap Mutual Funds?

Aggressive investors with a long-term investment horizon can consider investing in small-cap funds. You should have a high-risk appetite, and significant short-term fluctuations in the portfolio value should not affect you. It is recommended that investors should only have a small exposure to such funds.

While you can consider lump sum investment, you must have considerable knowledge to enter the fund at the right time when the markets are going through a bear phase. Due to this, most investors generally prefer the SIP route in such funds.

Now that you know what is small-cap mutual funds , how they work, their benefits, and who should invest, you can decide whether they are a good option for you or not. Rather than deciding you might regret in the future, it is better to consider professional help in case if you are uncertain.