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Small cap equity funds focus on investing in stocks from smaller companies usually those with a market value of less than ₹5,000 crores. Small cap companies refer to those listed on Indian stock markets with a market capitalization lower than that of the 250 largest companies. According to Securities and Exchange Board of India at least 65% of a smallcap fund’s investments should be in smallcap companies remaining 35% can be spread across large cap or mid cap companies, debt instruments or cash equivalents.
While these funds have the potential to outperform larger ones they also come with higher risks. If you’re considering investing in small cap mutual funds to benefit from the growth of promising smaller companies it’s crucial to be aware of the risk involved. Large investors often underestimate these small cap companies.
Looking at history small cap funds have shown better performance than other equity funds. However there’s a concentration risk because these funds focus on a smaller group of companies. Losses may occur if a subset of these companies underperforms.
It’s important to understand that small cap stocks are more sensitive to market changes leading to greater price fluctuations than larger stocks. This sensitivity explains the significant ups and downs in funds investing in these smaller stocks.
To find best small cap funds with consistent performance over the last decade or more it’s essential to grasp the nature of these funds and understand how they could contribute to your investment portfolio.
High Returns
These funds invest in small rapidly growing companies aiming for higher returns than large or mid cap funds. While they can outperform other investments in the long run but there’s a catch: they primarily invest in smaller companies (about 65%) bringing additional risks. Top small cap mutual funds can provide over 30% returns in individual years although the overall returns tend to stabilize over time.
High Volatility
Small cap stocks can be very volatile. When the market is uncertain or volatile these stocks are impacted the most. For instance small cap stocks were most affected during the COVID 19 pandemic in March 2020, when the market declined. So be prepared for some ups and downs if you invest in these stocks through these funds.
- Investing in small companies today could lead to big returns in the future if they become large cap companies. Small cap companies have the potential to grow more turning into major players. A million dollar company can become a billion dollar one then a billion dollar company can reach a trillion dollar valuation.
- Small cap companies are more volatile than larger cap because something that affects the economy can have a bigger impact on a small company than a larger one.
- Small caps are often more flexible and willing to change their brand, strategy and business approach. This gives them an edge during economic and technological shifts, unlike larger companies that may resist change. Investing in these smaller companies has the potential for larger growth mainly because they are proactive in expanding which can lead to long-term growth.
- Best small cap mutual funds typically invest in stocks of companies with huge potential for good returns. Skilled Fund managers thoroughly research to identify the best performing stocks and invest wisely. This allows investors to diversify their portfolios spreading their investments across different opportunities but with careful consideration of the risks involved.
- High Volatility: Small cap fund prices can be uncertain you might face bigger losses if they don't perform as anticipated.
- Risky Performance: The success of small cap funds depends on factors like stock selection and manager intervention leading to potentially less impressive performance.
- Low Liquidity: These funds aren't popular among big or individual investors causing liquidity concerns. Buying or selling units can be challenging.
- Market Risk: Small cap companies with lower market shares lack strong networks making them risky during economic downturns affecting their connections with customers, partners and employees leading to temporary impacts on stock prices.
- Financial Risk: Small cap companies may struggle to secure loans during challenging times because they don't have valuable stocks for collateral and might not be seen as credible by financial institutions. This adds to challenge of getting funding when required.
Review of Top Small Cap Funds
Further, in this blog, we will explore well known funds like Bank of India Small Cap Fund, Axis Small Cap Fund and Nippon India Small Cap Fund. We’ll break down their fund sizes, risk levels, and performance across different timeframes. This insight will empower you to make informed decisions in the ever-changing world of small cap investments
| Company Name | Fund Size (in Cr.) | Risk | Rating | 1Y Returns | 3Y Returns | 5Y Returns |
|---|---|---|---|---|---|---|
Bank Of India Small Cap Fund | ₹845 | Very High Risk | 5* | 47.24% | 34.28% | 33.04% |
Axis Small Cap Fund | ₹18,615 | Very High Risk | 5* | 39.16% | 30.47% | 28.70% |
Nippon India Small Cap Fund | ₹43,815 | Very High Risk | 4* | 53.17% | 40.49% | 30.21% |
Tata Small Cap Fund | ₹5,819 | Very High Risk | 4* | 40.07% | 37.82% | 28.54% |
Edelweiss Small Cap Fund | ₹3,002 | Very High Risk | 4* | 47.46% | 34.9
% | NA% |
ICICI Prudential Smallcap Fund | ₹7,091 | Very High Risk | 4* | 42.01% | 33.48% | 28.59% |
Kotak Small Cap Fund | ₹14,082 | Very High Risk | 4* | 39.53% | 30.81% | 28.43% |
Quant Small Cap Fund | ₹13,001 | Very High Risk | 3* | 55% | 46.25% | 35.01% |
IDBI Small Cap Fund | ₹160 | Very High Risk | 3* | 24.28% | 39.12% | 16.6% |
HSBC Small Cap Fund | ₹13,230 | Very High Risk | 3* | 50.95% | 37.64% | 24.87% |
HDFC Small Cap Fund | ₹26,836 | Very High Risk | 3* | 50.10% | 36.30% | 23.90% |
Franklin India Smaller Companies Direct Fund | ₹11,397 | Very High Risk | 3* | 58.99% | 35.19% | 24.56% |
Canara Robeco Small Cap Fund | ₹9,174 | Very High Risk | 3* | 36.93% | 34.87% | NA% |
Invesco India Smallcap Fund | ₹3,461 | Very High Risk | 3* | 50.15% | 34.26% | 27.65% |
SBI Small Cap Fund | ₹23,716 | Very High Risk | 3* | 30.12% | 26.05% | 25.26% |
Factors Consider Before Investing in Small Cap Mutual Funds
Considerations before investing in small cap mutual funds:
- Risk Factor: Small cap funds are more volatile than large & mid cap and their net asset value can fluctuate dramatically. Due to high volatility these funds offer growth opportunities for investors comfortable with taking risks.
- Investor Expertise: Due to their high volatility small cap funds are suitable for investors with good mutual fund investment knowledge and expertise.
- Investment Term: These funds are best for long term investors and are not suitable for those with short investment horizon. High level of research required on small cap companies before investing.
- Personal Goals & Risk Tolerance: Assess whether small cap funds align with your financial goals and risk tolerance. They carry a "high return/high risk" profile making them suitable for those comfortable with higher risks.
- Fund Management: Understand how the fund is managed and the allocation of assets by the fund manager. This insight can help evaluate the fund's potential performance.
- Expense Ratio: Every fund charges a fee for managing your investment known as the expense ratio. Keep an eye on this ratio because a higher expense ratio can mean lower returns. A lower expense ratio is better for your returns.
How Do Small Cap Funds Work?
According to SEBI guidelines, Small Cap Equity Funds are required to invest at least 65% of their assets in stocks of small cap companies. Small cap companies include those ranked below the top 250 largest companies in India by market capitalization.
Because these funds focus on smaller companies, they have the potential to offer high returns. However, they also carry a high level of risk due to their sensitivity to changing market conditions. For this reason, experts recommend that investors keep only a small portion of their portfolio in small cap funds to manage the potential impact of volatility. Holding a balanced portfolio with a mix of larger, more stable investments alongside small cap funds can help reduce risk while still capturing the growth potential these funds offer.
Who Should Invest in Small Cap Mutual Funds?
Small-cap funds are a good fit for:
- Diversification Seekers: Investors already in the market looking to diversify benefit from small cap funds. These funds though risky spread investments across various forms not just small caps.
- High Risk Takers: For those comfortable with higher risks small cap funds being riskier than mid or large-cap funds can be a suitable choice especially for investors willing to face potential downturns.
- Long Term Investors: Despite short term fluctuations small cap funds tend to perform well over the long term. Best small cap mutual funds may diliver above 25% return annually. They are ideal for investors willing to stay invested for long term investor who wants to invest for 5 year or 7 year.
Taxation of Small Cap Mutual Funds
- Dividend Taxation: Dividends received are added to taxable income and taxed based on the investor's income bracket. Additionally, there's a 10% TDS on dividends exceeding ₹5000 in a financial year.
- Capital Gains Taxation:
- Long Term Investment (held for one year or more): If the investor withdraws after one year a 10% tax applies on gains above ₹1 lakh per financial year. No taxes are due if gains are below ₹1 lakh.
- Short Term Investment (withdrawn before one year): If an investor withdraws funds before one year a 15% capital gains tax is imposed along with any applicable exit load.
Frequently Asked Questions
Q1. Are small cap funds a good choice for new investors?
Small cap funds can offer impressive returns and rapid growth but they are also highly volatile, especially compared to mid cap and large cap funds. Due to this volatility, they’re better suited for experienced investors who are comfortable with market fluctuations.
Q2. What kind of returns can I expect from small cap funds?
In the long term, small cap funds have the potential to deliver stable and rewarding returns. However, in the short term, they can be quite unpredictable due to market fluctuations which may impact results.
Q3. Is investing in small cap funds risky?
Yes, small cap funds come with a higher risk especially over the short term as they are more prone to major market swings. However, if held for the long term, they often balance out, offering the potential for substantial returns.
Q4. Are small cap funds suitable for short term investments?
Small cap funds are generally better suited for long term investments. They tend to perform best over an extended period, where their high growth potential can be realized.
Q5. Who should consider investing in small cap funds?
Small cap funds are usually best for investors who are knowledgeable and experienced with mutual fund investments. Their volatility can make them challenging for new or conservative investors.
Q6. How long should I stay invested in small cap mutual funds?
Since small cap funds primarily invest in stocks, a minimum investment period of at least 5 years is generally recommended to allow the investment to grow and balance out short term volatility.
Q7. Where do small cap mutual funds invest?
By regulation, small cap mutual funds must invest at least 65% of their holdings in stocks of companies ranked 251st and below in terms of market capitalization in India. Some funds also allocate a small portion to mid cap or even large cap stocks but the primary focus remains on small cap stocks, keeping the risk reward potential intact.
Q8. Should I invest in small cap mutual funds?
Small cap funds provide exposure to emerging companies, some of which may grow into mid sized or even large companies in the future. While they can be very volatile in the short term, staying invested over a longer period can yield market beating returns.
