What are Small Cap Mutual Fund?Who should invest in Small Cap Funds?

What are Small Cap Mutual Fund?

Small-Cap Funds refer to those mutual funds which primarily invest in companies which have been ranked below 250 in terms of market capitalization. Small-Cap funds invest in equity and equity-related instruments of companies to take advantage of their high growth potential. These funds allocate at least 65% of their total assets in small-cap equity and the rest can be invested in any of the large, mid or small cap equity.

Features of Small Cap Funds

• Investment Style: These funds invest in smaller companies which include start-ups or small revenue generating companies which are in the early stage of development

• Risk Involved: Small cap Funds are highly risky because such stocks have higher chances of getting affected by market recessions. They take a lot of time to recover from these effects of market fluctuations. Also, such funds offer less liquidity as compared to other fund types and require an intrinsic research of stocks for better returns

• Returns: These funds are known for generating higher returns because the companies in which they invest have a high potential of growth in future. Small cap funds perform better than large and mid cap funds during bullish market when the prices of stocks rises

• Investment Horizon : Small cap funds undergo severe decrease in returns when the market is in downturn. Thereby, in order to generate higher returns, you must keep yourself invested for a longer period of time. So, it is suggested that the investors of small cap funds should take an investment horizon of 5 to 7 years to get expected returns

• Costs Involved:  Apart from the initial investments, investors of small cap funds are subject to an annual charge called Expense ratio. The maximum expense ratio is 2.5% of the average of Assets Under Management (AUM). Investors investing in funds with lower expense ratio are able to generate better returns

• High growth potential: If you invest in the right set of stocks, small cap funds have exponential growth potential and can give higher returns than other fund types

• Diversification: It is considered that diversification leads to decrease in market risks and small cap funds deliver a good space for diversification in the fund’s portfolio. A healthy mix of investment in your portfolio acts as a buffer against major losses.

• Benefit from Market pricing: Small cap companies have not yet emerged as full-grown businesses which makes it difficult to find information about the stocks compared to large and mid-cap companies. Hence, there are high chances of inefficient pricing of small cap stocks. The investors of such stocks can take leverage of the inefficiency in the market pricing and earn higher returns

• Flexibility: As compared to large cap funds, small cap are more flexible and can adapt to changes more easily

• Individuals who are willing to invest in emerging businesses which are not yet established.

• If you are an individual with high risk appetite, looking for an fund with longer investment horizon (5-7 years), you could consider small cap funds.

• If you have high returns expectations, you can invest in small cap funds.

• Small cap funds are suitable for investors with long term goals like child’s education, retirement etc.

• Offline mode– Visiting the nearest branch office of the fund house and investing in the desired scheme. You must carry all the required documents such as Identity Proof, Address Proof, Cancelled Cheque, Passport size photos, PAN Card and KYC Documents handy. You can also invest offline through a broker. However, this would then be a regular fund and not a direct fund. Think of it like a  charge brokerage which gets deducted from the total investment amount.

• Online Portal– If you want a hassle free mode of investing with no commissions and brokerage, you can choose websites which allow the investors to compare more funds at one platform instead of visiting the website of each AMC and then searching for numerous funds. You can select the fund in which you want to invest, look at the details and compare similar schemes as well as use SIP Calculator or Lumpsum Calculator to estimate the future value of your investment

Advantages

Who should invest in Small Cap Funds

Things to Consider Before Investing in Small-Cap Funds

1. Risk Appetite: Compared to Large-Cap and Mid-Cap funds, Small-Cap funds have a high-risk element, as small-cap companies are highly market sensitive and prone to price volatility. A potential investor should carefully assess his risk appetite and then choose a fund accordingly. Though you can minimize the risk by staying invested for the long term, small-cap funds are meant for investors with a high-risk appetite.

2. Past Performance of the Fund: To reap maximum benefits from investment in small-cap funds, it is a good practice to have a look at the past performance of the fund under consideration. If the fund has performed well consistently in the past, that means the fund has been managed well and is expected to do well in the near future.

You can compare the 1-year, 3-year and 5-year returns of the fund with its benchmark and category returns as well. If the fund has generated attractive returns and also outperformed its benchmark and category returns, the fund can be opted  for.

3. Diversification of Investment Portfolio: An investor should invest in a fund whose portfolio is diverse. A small cap fund that invests in companies from different sectors and industries is a good choice, as this hedges it against a possibility of downfall of any particular market.

While a concentrated portfolio increases the risk, over-diversification takes away the return potential. So it is important for a fund to be well-diversified to balance the risk quotient.

4. Investment Time Horizon: If you are looking for short-term gains, then investment in small-cap funds is not a good idea as small-cap companies are quite vulnerable to economic downturns and other types of market volatility. An individual should have a longer outlook to get the best out of their investment.

The past performance records of small-cap funds suggest that they are the best to invest in with a 5+ year investment horizon. Further, the power of compunding will also work in your favour if you stay put for the long run.

5. Expense Ratio of the Fund: Expense Ratio refers to an annual fee that an Asset Management Company charges to manage your assets. It is a specific percentage on your investment returns. You should choose a fund which has a low expense ratio, as high expense ratio decreases your Net Asset Value (NAV) thereby decreasing your effective payout at the time of redemption.

How to Invest online in Small Cap Fund?

There are different methods through which one can invest in small cap stocks:

 

Some of Small-Cap Mutual Funds: 

Axis Small Cap Fund, 

L&T Emerging Businesses Fund, 

HDFC Small Cap Fund, 

Nippon India Small Cap Fund. 

Taxation

The short-term capital gains (capital gains earned on holding period up to 1 year) are taxed at 15% whereas long-term capital gains exceeding Rs.1 Lakh will be taxed at 10%

The scheme charges an Exit Load of 1% in case the investments were made for less than a year, so if you need emergency funds you will have to bear the load.