Understanding Small Cap Funds
By Akhil Chugh
Date January 22, 2023
Higher returns on investments play a significant role in achieving wealth maximization in the long term. However, higher returns come with higher risks too. With valuations in the small-cap space now down significantly, Net Brokers believe investors could go for a staggered investment in Small Cap Funds to minimize the risk and generate returns in the long run.
In this blog, we will learn more about Small Cap Mutual Funds, and their advantages. Let’s also understand the different parameters that one should know before investing in them.
What are Small Cap Funds?
Small Cap Funds are those which invest a major portion of their investible corpus into equity or equity-related instruments of small-cap companies. As per SEBI, Small Cap Funds need to invest min 65% of their total assets in small-cap companies. Small-cap companies are those which are ranked 251 and beyond in terms of market capitalization.
Small Cap Funds typically have the highest growth potential since the underlying companies are young and seek to expand aggressively. Quality small caps can be a great investment opportunity in the long run.
Small Cap Funds promise to capture the growth stories early on by investing in tomorrow’s mid-cap or large-cap companies. Being small has its set of advantages; management is active enough to capitalize on business opportunities during the good times. However, they are also the most vulnerable and volatile when the tide turns.
Small Cap Funds are ideal for aggressive investors who seek higher returns and are comfortable with high volatility.
Why invest in Small Cap Funds?
High growth potential: Small Cap Funds choose to invest in new and emerging businesses, where large-cap firms haven’t made inroads, yet. So, they give investors exposure to different, niche and emerging sectors like chemicals, textiles, sugar, construction and more. Thus, they can be wealth generators in the long run.
Untapped potential: Small-caps are underfollowed in the stock market and are usually untapped by institutional investors, giving a huge opportunity to wise investors to grow their investments. The under-researched and under-owned nature of the small caps gives them a lot of scopes to expand in the future. Even a novice investor can take advantage of this untapped potential with Small Cap Funds. The key is to stay invested in Small Cap Funds throughout the full recovery or growth phase to reap the benefits from them.
Diversity of options: As the small-cap universe is large, every small-cap fund is different. Small Cap Funds provide exposure to diversified sectors for investment.
Average out risks and costs: SIPs can help average your investments, reducing your risk substantially. Diversification across companies is very good because for small companies, you don’t have plenty of information to decode and understand. Staggered investments through SIPs can help overcome this uncertainty and market volatility.
Factors to Consider While Investing in Small Cap Funds:
1. Risk Profile of the Investor:
Small Cap Mutual funds face high market risk. Any changes in the market will reflect a change in the fund’s net asset value (NAV). At a point when the market is bearish, the Small Cap Fund will in general experience a fall. Then again, when the market is bullish, the Small Cap Funds have an incredible capacity to deliver more outstanding returns than other mutual fund types. Small Cap Fund is suitable for an investor with high-risk appetite.
It is preferable to take exposure to small-cap space through Small Cap Mutual Funds as these funds are managed by qualified and professional experts and are backed by a dedicated investment research team that analyses the performance and prospects of companies and selects suitable investments.
2. Investment Horizon:
Patience is the key virtue for successful investing in Small Cap Funds. The minimum holding period should be 7 years plus to beat the market volatility & earn returns from them.
3. Fund Manager’s Experience:
Check fund managers past performance record of the various other funds managed by him. Investing in Small Cap Funds is extremely challenging – identifying promising companies, taking meaningful stakes well in advance, and holding on to them patiently to make money. Only a very few fund managers have managed to deliver superior reruns over a long period.
4. Fund House Quality:
Checking the track record of a Small Cap Fund is necessary. Don’t invest based on near-term or one-year returns. Instead, look for consistent and stable funds from reputed fund houses with experienced fund managers.
5. Investment Philosophy:
Investors should be comfortable with the investment philosophy of the funds they are looking at and it should be in line with their portfolio objectives. This is of particular importance during periods of increased volatility when investor patience can be severely tested and it will also help them stay invested to truly benefit in the long term.
6. Don’t Over-invest:
Small Cap Funds should ideally be only 5-10% of an investor’s overall portfolio. Small-cap companies have great potential for growth but also carry a significantly higher level of risk. Thus, Small Cap Funds should not be your core portfolio. Net Brokers suggest taking a calculated exposure to Small Cap Funds.
Before investing in Small Cap Mutual Funds, one must keep in mind the amount of risk they can handle, their financial objectives, investment horizon. These are some parameters one should always keep in mind before deciding to invest in lucrative, but risky Small Cap Funds.
If you have the necessary risk profile and a long-term investment horizon, invest in Small Cap Funds regularly over a long period, irrespective of the market conditions.
Net Brokers believe investing in these funds can boost investor’s portfolio returns significantly. Invest in Small Cap Funds through a systematic investment plan (SIP). It will average out the cost thus decreasing the impact of volatility.
Get in touch with us to help you choose the right Small Cap Funds for your goals.
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Happy investing!