Is it the Right Time to Continue Investing in Small and Mid-Cap Funds?

30 September 2022
6 min read

This location may have the solution if you keep investing in Small-Cap and Mid-Cap Funds. Yes, we know that investors are swarming to India to purchase Small and Mid-Cap Funds, but if you have any doubts or are curious about what the future holds for the money you have invested or desire to invest, keep reading.

Yes, these funds that fit into this category have enormous returns, but they also come with a price: Risks. So, let's tackle Small and Mid-Cap Funds separately, one at a time.

Should You Consider Investing in Small-Cap Funds?

A significant portion of the investable corpus of Small-Cap Funds is placed in equity or equity-related tools of small-cap companies. Small-Cap schemes are required by the Securities and Exchange Board of India (SEBI) to allocate at least 80% of their asset value to Small-Cap Firms.

Additionally, SEBI defines Small-Cap companies as those whose market capitalization ranks them below the 250th position. These businesses have a market capitalization of fewer than 500 crores of rupees.

It's important to remember that small-cap funds are hazardous. The share prices of small-cap companies can be significantly impacted by even the smallest amount of market volatility. However, these stocks have great potential to provide incredible returns. Consider that a small business has enormous potential for expansion, which would result in a sharp rise in the share price.

For short-term investment requirements, however, many investors are inclined to turn to Small-Cap schemes. However, this could be counterproductive because small businesses require time to develop. As a result, choosing Small-Cap Funds is typically advised if you have a high-risk tolerance and a long investment horizon.

Advantages of Small-cap Funds

  • Gain from making early investments in businesses that could become market leaders.
  • A lack of financial stamina brings on high-risk exposure to withstand challenging market conditions.
  • Perfect for highly aggressive investors with a 7+ year investment horizon or plan.

Factors to Consider Before Investing in Small-Cap Funds

Before investing in Small-Cap Funds, investors should think about the following factors-

  • Small-Cap Funds' Return Potential and Risk Avenue

A Small Cap Fund's Net Asset Value (NAV) is responsive to changes in its underlying benchmark. As a result, many Small-Cap Funds experience losses when market conditions are poor. Nevertheless, it's a fantastic opportunity for investors who are prepared to take a chance and seek rapid growth.

In India, the Small-Cap sector has experienced phenomenal growth in recent years. The returns from Small-Cap Funds could reach 100% or higher in only one day. Of course, risks arise in Small-Caps and investments as a whole, but avoiding them is not the right solution. If you lose the part of investing in small funds, you might miss out on the magic of the returns.

  • Choose A Plan with A Lower Cost-to-Income Ratio

You must comprehend the idea of the Expense Ratio if you are new to investing. Every fund house spends money managing your money. It recovers these expenses by levying a fee known as the Expense Ratio. This represents a portion of the scheme's overall assets.

Additionally, SEBI has established a 2.50% maximum expense ratio. Therefore, selecting a strategy with a lower Expense Ratio is crucial because it reduces your returns.

  • Small-Cap Funds Outperform in The Long Run

Small-Cap Stocks are highly vulnerable to market fluctuations. As a result, when the market falls, these stocks are likely to suffer the most. As a result, when investing in Small-Cap Funds, it is critical to have a long-term investment horizon to ensure that your investment has enough time to generate returns.

Eight to ten years is the recommended time frame, and Small-Cap Funds are just right for you if you have held an aggressive profile with an investment horizon for ten years or more.

  • Not Recommended for An Investor Hesitant Towards Taking Risk

 When you have the stomach for higher risks, you can consider investing in Small-Cap Funds. Small-Cap Funds have a great chance of outperforming benchmark returns. However, these are hazardous investments, so you should only think about them if you can handle price volatility.

Additionally, you can increase your efforts to create wealth by allocating a small portion of your portfolio to Small-Cap stocks and staying invested for a long time.

Should You Consider Investing in Mid-Cap Funds?

Mid-Cap Funds make investments in the stock and securities of Mid-Cap companies. Mid-Cap companies, as defined by the Securities and Exchange Board of India (SEBI), fall between positions 101 and 250 on the list of companies based on market capitalization.

To give you a good idea, the 101st company on the list has a market cap of about 30,000 crores of rupees, while the 250th company's market cap is about 9,500 crores.

Mid-Cap companies offer advantages and disadvantages to both Small-Cap and Large-Cap companies because they sit in between. Although they are more volatile than Large-Cap Funds, Mid-Cap Funds typically have higher returns.

On the other hand, they tend to offer lower returns while being more stable than Small-Cap Funds. Mid-Cap Mutual Funds, in a nutshell, provide the ideal balance of risk and return.

As an investor, you can anticipate much higher returns if you choose the schemes carefully and include a great selection of stocks, sector diversification, and a good fund manager. In addition, funds are typically advised if you have a high-risk tolerance and a long investment horizon.

Advantages of Mid-cap Funds

  • Exposure to high-growth stocks that have the potential to outperform the market.
  • They are more likely to struggle in challenging market conditions because of their smaller size.
  • Appropriate for active investors with a 7+ year time horizon.

Factors to Consider Before Investing in Mid-Cap Funds

Before investing in Mid-Cap Funds, investors should think about the following factors-

  • Long-Term Investors Should Consider These Funds

Since most equity investments are volatile, making a longer-term investment helps to ensure good returns. Some of the Mid-Cap companies that are currently growing will become tomorrow's Large-Cap companies.

As a result, to profit from investing in Mid-Cap stocks, you must have an investment horizon of eight to ten years.

  • Mid-Cap Fund Returns

Mid-Cap Funds typically have a long track record of outperforming the market in terms of returns. They could, however, perform poorly in short to medium term. Therefore, if investors want to profit from this fund category, they must be ready to maintain their investment.

While Mid-Cap Funds are riskier than Large-Cap Funds, they also offer investors the chance to outperform the market. Therefore, only investors willing to take risks should choose this fund category.

  • Risk Avenue

Not all Mid-Cap businesses develop into Large-Caps. There have been occasions of Mid-Caps filing for bankruptcy in a challenging market.

Even though that is an extreme case, the Mutual Fund that owns the business or the businesses concerned may not generate the expected returns if the company cannot meet its return expectations.

  • Expense Ratio

Every fund house levies an expense ratio to cover office and fund management expenses. It represents a modest portion of the fund's overall assets. The maximum Expense Ratio allowed under SEBI's mandate is 2.50%. A program with a lower expense ratio will provide you with higher returns on your investment.

Conclusion

Finally, you might consider selecting Mid-Cap and Small-Cap Funds that significantly beat their peer groups and benchmark indices. Additionally, it would help if you looked at how they perform in a bearish trend.

You can see if these Mid-Cap and Small-Cap Funds can control downside risk during a bear market. First, check the Mid-Cap and Small-Cap Funds portfolios to see where your money is being invested.

Instead of your core portfolio, include these funds in your satellite portfolio. It adds to the returns on your entire portfolio while making up a relatively small portion of it.

Disclaimer

The stocks mentioned in this article are not recommendations. Please conduct your own research and due diligence before investing. Investment in securities market are subject to market risks, read all the related documents carefully before investing. Please read the Risk Disclosure documents carefully before investing in Equity Shares, Derivatives, Mutual fund, and/or other instruments traded on the Stock Exchanges. As investments are subject to market risks and price fluctuation risk, there is no assurance or guarantee that the investment objectives shall be achieved. NBT do not guarantee any assured returns on any investments. Past performance of securities/instruments is not indicative of their future performance.
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