What are Small Cap Mutual Funds?
Based on market capitalization, funds can be categorised as large-cap, mid-cap, or small-cap. The SEBI has made certain changes to the definition of small-cap funds based on the following rankings: Small-cap funds are those with a market size of less than Rs. 5,000 crores.
- The top 100 stocks by market capitalization include large-cap funds.
- The following 101 to 250 ranked equities by market capitalization are mid-cap funds.
- Stocks and funds with a ranking of 251 or below are considered small-cap.
The capitalization of a company, as measured by the total market value of its publicly traded shares, is referred to as the “cap” in small-cap stocks. Stocks of publicly listed companies with a market capitalization of less than Rs 5,000 crore are often referred to as small-cap stocks. Technically speaking, because the underlying companies are new and want to grow quickly, they are more volatile and susceptible to losses during market downturns. The fund manager of a small-cap fund must allocate at least 65% of the portfolio to small-cap equities.
Individual investors have a competitive advantage over institutions thanks to small-cap stocks. Due to their stability, institutional investors favour buying large-cap equities, whilst investors seeking aggressive returns would participate in these funds. Additionally, fund composition is important, and a rash selection will put your investment at risk.
List of best small cap mutual funds in India:
| Scheme | 3 Year Return of Regular Plan (%) | 3 Year Return of Direct Plan (%) |
| Quant Small Cap Fund | 51.39 | 53.31 |
| Bank of India Small Cap Fund | 39.76 | 42.2 |
| Canara Robeco Small Cap Fund | 39.26 | 41.67 |
| Nippon India Small Cap | 35.56 | 36.75 |
| Edelweiss Small Cap Fund | 33.74 | 35.93 |
| Kotak Small Cap Fund | 33.66 | 35.58 |
| Tata Small Cap Fund | 31.70 | 34.13 |
| Union Small Cap Fund | 32.87 | 33.92 |
| DSP Small Cap Fund | 31.74 | 32.92 |
| SBI Small Cap Fund | 30.84 | 32.28 |
| ICICI Prudential Smallcap Fund | 29.87 | 31.75 |
| Sundaram Small Cap Fund | 29.10 | 30.59 |
| Invesco India Smallcap Fund | 28.34 | 30.41 |
| L&T Emerging Businesses Fund | 28.78 | 30.2 |
| Axis Small Cap Fund | 27.85 | 29.93 |
| IDBI Small Cap Fund | 28.58 | 29.84 |
| HDFC Small Cap Fund | 26.31 | 27.58 |
| Franklin India Smaller Companies Fund | 24.47 | 25.52 |
| HSBC Small Cap Equity Fund | 22.89 | 24.66 |
| Aditya Birla Sun Life Small Cap Fund | 20.97 | 22.3 |
| IDFC Emerging Businesses Fund | NA | NA |
| ITI Small Cap Fund | NA | NA |
| PGIM India Small Cap Fund | NA | NA |
| UTI Small Cap Fund | NA | NA |
Features Of Small-Cap Funds:
- Small-cap funds are required to devote at least 65% of their investment corpus to small-cap equities, in accordance with Securities and Exchange Board of India (SEBI) regulations.
- They make investments in small-cap companies. Start-ups and small-revenue businesses that are still in the planning stages are among them.
- The companies that small-cap mutual funds invest in are poised for significant future development.
- Small-cap funds are prone to volatility. Small-cap enterprises lack financial stability, which is why this is. They are not as well established as larger companies.
- Small-cap investments carry risk. For investors that are very capable of accepting risks and are searching for rapid growth, they can produce tremendous profits.
- During a bull market, small-cap funds beat mid- and large-cap mutual funds. When share prices increase, more people buy, this is known as a bull market.
- During a bad market, small-cap funds perform substantially worse than mid- and large-cap funds. When share prices fall, it is known as a bear market and selling is encouraged.
Taxability on Small Cap Mutual Funds:
Investors must pay taxes on capital gains earned on small-cap equity funds. These taxes must be paid upon redemption of the funds. The computation of taxes relies on the duration of the fund investment. This is the overall time you have invested in the mutual fund. It is also known as the fund’s holding period.
Capital Gains are of two types:
Short Term Capital Gains (STCG): Capital gains from the redemption of funds held for less than one year. The tax on STCG is 15 percent.
Long Term Capital Gains (LTCG): Capital gains from investments held for more than one year. If the sum exceeds one lakh rupees, a 10 percent tax is calculated. The tax only applies to amounts above one lakh rupees. Any value below one lakh rupees is excluded from the tax computation.
Another tax applicable to the returns of small-cap mutual funds is the Dividend Distribution Tax (DDT). It applies if you are investing in the fund’s dividend-paying variant. It applies to all dividends received throughout the holding period. Before distributing the dividend relevant to your investment, the fund company will deduct a DDT of 10%.
Small Cap Funds Are Best Suited For:
The volatility of small-cap companies is what drives the performance of small-cap mutual funds. They are perfect for investors who are willing to assume greater risk for the possibility of greater reward. You should only consider investing in small-cap mutual funds if you have a high risk tolerance. Keep in mind that when the market is down, your returns may be substantially lower. You should consider the fast expansion of small-cap companies’ finances. It makes the share prices of these companies more volatile and susceptible to losses in the event of a market decline.
Diversify your portfolio to prevent losing all of your money at once, as advised by experts. Therefore, you must invest with prudence and incorporate both small and mid-cap funds in your portfolio. It provides protection if your small-cap funds fail. Even the majority of small-cap fund schemes invest between 80 and 90 percent in small-cap firms. The remainder of their investments are in mid-cap firms.
Important considerations for investors
- Risk
The volatility of small-cap funds is greater than that of large- and mid-cap funds. Small-cap funds suffer greatly during periods of poor market performance since they are less established. On the other hand, it is an excellent investment opportunity for individuals who can accept greater risk and seek more aggressive development.
Returns Over the past several years, the market has witnessed the small category perform remarkably well, attracting a great deal of investor attention and capital. Small-cap funds are believed to have considerable but hidden potential to become a “multi-bagger” (Indian financial jargon for an equity stock with a return of more than 100%) in the future.
- Cost
The expense ratio is the annual cost charged by small-cap equities mutual funds to manage your capital. SEBI has marked the upper limit for this at 2.25% of the average asset under management. In the end, a reduced expense ratio corresponds to greater returns. Therefore, while shortlisting funds, choose those with the lowest expense ratio.
- Investment Horizon
When the market begins to decline, small-cap funds suffer a significant loss of returns. Therefore, for the fund to provide returns consistent with your objectives, you must remain invested over the long term. A long-term investment horizon is when this choice is considered for 7 to 10 years.
- Financial Goals
Small-cap equity funds may be appropriate for investors with long-term objectives such as planning for the education of their children, saving for retirement, taking an exotic trip with their family, paying off their medium-term debt, etc. Historically, when markets are optimistic, these funds have generated larger returns than the broad benchmark. However, these wagers might become quite hazardous. Those with a high risk tolerance may thus consider investing in these funds. These funds invest in firms with a high potential for yielding favourable returns.
Major Advantages
Investing in Small Cap Mutual Funds offers you the following advantages:
- Small-cap funds have a strong growth potential since they invest in new firms with more expansion potential. These businesses are more able to grow their operations than larger businesses.Small-cap firms are underreported since the majority of them are undiscovered. Consequently, they have minimal analyst coverage. There is a significant likelihood that they are undervalued, and as a result, small-cap mutual funds offer an attractive investment option. Such firms are ideal for investors who are okay with much greater levels of risk.
- Adding small-cap funds to your portfolio allows you to achieve a balanced risk-return profile. Consequently, these funds allow you to diversify your assets, so minimising your total risk.
- Small-cap firms have a larger potential of undergoing mergers and acquisitions. To grow inorganically, they may be purchased or merged with its bigger equivalents. As a result, the share price of smaller firms may increase, so boosting the value of small-cap funds.
- Small-cap firms are lightly traded on the stock market, resulting in little liquidity. Although some investors view this as a disadvantage. It is favourable for investors who see the company’s potential. Once the company’s results and revenue are made public by management, a huge number of investors may rush to purchase its shares. As a result of the strong demand for and limited supply of publicly traded shares, the price of these shares rises sharply.
FAQs
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How Much Should You Invest in a Small-Cap Fund?
You must maintain perspective on exposure to small cap funds. When allocating funds to large cap, mid cap, and small cap funds, the optimal proportions should be 70:20:10 for large cap funds, mid cap funds, and small cap funds, respectively. This will ensure that you benefit from the diversity and alpha power of mid-cap and small-cap funds.
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What Should I Look for in a Small Cap Fund’s Portfolio?
Since small cap funds are highly heterogeneous, the only way to make a call on the fund is to examine the fund’s portfolio in depth. Too many speculative stocks in a portfolio should raise red flags. There are plenty of promising small cap companies, and you need a small cap fund that invests in compelling tales.
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Is It True That Debt Is Unfavorable to Small-Cap Stocks?
To a certain extent, debt is detrimental to all stock kinds. In the case of small-cap companies, however, a special issue exists. The majority of small cap stocks are concentrated in a particular industry or are reliant on a small client base. Therefore, a greater financial risk of debt might be hazardous for such businesses. Small-cap stocks with a high debt-to-equity ratio or a significant capital base should be avoided.
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How Useful Are Historical Returns When Choosing Small Cap Funds?
Even if past returns are not necessarily predictive of future performance, they are a sufficient sign of the quality of the small cap fund and its portfolio. Focus more on the regularity of returns than their magnitude. If a small-cap fund has performed well for eight consecutive quarters on a rolling three-year period, you can assume that it will continue to perform well in the future. This is one of the most comprehensive assessments of small cap funds.
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Are small-cap funds without risk?
No, small-cap funds represent a substantial risk over the short to medium term. However, if they are well-balanced in your investing portfolio, they might yield lucrative returns over time. Before investing in small-cap funds, it is usually wise to conduct thorough research.
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Why invest in small-cap mutual funds?
Small-cap funds are invested in firms that are anticipated to grow over time. Therefore, if you invest in these firms, you may anticipate a substantial return over time. However, you must keep an eye on the performance of your funds and the reputation of your fund management; these considerations will help you decide whether or not to invest in the fund.
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How long should small-cap funds be held?
As a general rule, the longer you invest in leading small-cap funds, the better. It is advised that you invest for at least 5 to 7 years in these firms in order to maximise your return.
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Is the risk associated with small-cap funds worthwhile?
Actually, it depends. If you have a high risk tolerance and can invest for 5 to 7 years, it is prudent to invest in Small Cap Funds. In order to minimise short-term performance fluctuations, it is also suggested that you do not overload your portfolio with small-cap funds.
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