Thinking of investing in an equity mutual fund?

Well, we know it is crucial to decide the most appropriate category – i.e. large cap, mid cap, small cap, multi-cap or sectoral. Each category has its own advantages and disadvantages.

Why Are Small-Cap Funds Not For All Kinds of Investors?

Small-cap mutual funds have given stellar returns. But have you ever wondered, ‘what are the disadvantages of small-cap funds?’.

Here are 3 reasons why you should stay away from small-cap funds. But wait, if these 3 points are not a problem, you should definitely invest in small-cap funds.

1. Risk

Small-cap mutual funds are very risky. Which means, in the short term, investing in them could lead to short-term losses.

If you cannot tolerate seeing negative returns on your investments at certain periods, you should stay away from small-cap funds.

Let me show you what I am talking about.

This is Reliance Small Cap Fund‘s performance over the last 1 year. As you can see, after peaking around January 2018, it has almost fallen to levels it was at about 1 year ago.

Will it rebound? I don’t know. But in history so far, it has.

If you cannot see such sharp ups and downs, it is better to stay away from small-cap funds.

Explore investing in Large Cap Funds instead.

Check out: Best Large Cap Funds for 2018. 

2. New Investor

Are you a new investor?

Don’t simply get swayed by the higher returns.

In fact, for new investors, it would be best to start investing in other category mutual funds. Once you have some idea of the performance of mutual funds, you can explore small-cap funds.

These funds are best suited for investors who have a very good idea about mutual funds and the risks associated with them.

3. Short Term Investor

If you are investing in mutual funds for a short duration, stay away from small-cap mutual funds.

Small-cap mutual funds perform well over a long period of time. Over a short period of time, they tend to be very volatile.

So if you plan on withdrawing/redeeming your money from the mutual fund early, you could suffer losses. Sure, you could also make gains, but there is always the risk.

Hence, if you are a short-term investor, stick with low-risk debt mutual funds.

As for small-cap mutual funds, you should remain invested for at least 5-6 years.

Read: Best Debt Funds for 2018.

How to Invest in Small Cap Funds

1. SIP/STP

It is a good idea to invest in small-cap funds via SIP (Systematic Investment Plan).

SIP refers to investing a fixed amount in a mutual fund every month. What SIP does is it spreads your risk over a large period of time.

If you have a large sum of money you want to invest, SIP is not the best option to go with. Instead, explore the STP (Systematic Transfer Plan). 

In STP, you invest your money in a debt mutual fund. And then, you gradually transfer that money to an equity mutual fund of your choice.

It is like starting an SIP but instead of paying from your bank account, you are paying from a debt fund.

This allows you to earn a higher rate of return as debt funds give higher returns when compared to savings bank accounts.

2. Long Term

With small-cap mutual funds, always opt to invest for the long term. The minimum period for which you should be investing in small-cap mutual funds is 5-6 years.

As mentioned earlier, small-cap mutual funds tend to be very volatile. They may go up and down in the short term.

Over a long period of time, they tend to give good returns.

Take a look at Reliance Small Cap Fund’s returns over 1 year and 5 years. You will notice that the fund performs very well over a period of 5 years, but in a year’s time, its performance hasn’t been very great.

Reliance Small Cap Fund 1 Year Returns

Reliance Small Cap Fund 5 Year Returns

reliance small cap 5 year returns

 

3 Best Small-Cap Funds of 2018.

1. HDFC Small Cap Fund

This is one of the most popular small-cap equity oriented mutual funds in the market right now.

Launched on 1 January, 2013, this is a fund with high risk and has given a return of 21.39% since its launch.

Returns of HDFC Small Cap Fund

Duration Returns (per annum)
1 year  17.4%
3 year  21.1%
5 years  25.3%

Key Features:

  • This is a 5-star rated fund by Groww.
  • It has an AUM of ₹ 4,043 Cr approximately
  • Age is nearly 5 years. So its performance can be easily judged.
  • Has consistently outperformed its benchmark, Nifty Free Float Small cap 100, since its launch.
  • You can invest in this fund with minimum SIP of ₹500.

2. L&T Emerging Businesses Fund

This is a relatively new small-cap fund, launched on May 12, 2014. It has certainly made its mark in a short span. It is a fund with high risk and has given a return of 27.18% since its launch.

Returns of L&T Emerging Businesses Fund

Duration Returns (per annum)
1 year  9.3%
3 year  23.5%
5 years  NA

Key Features:

  • This is a 5-star rated fund by Groww.
  • It has an AUM of ₹ 4,934 Cr approximately
  • Age is nearly 4 years. So its performance can be difficult to judge in the long run. Though its a relatively new fund, it has made its mark with high returns on investment.
  • You can invest in this fund with a minimum SIP of ₹500.
  • This fund has exponential growth potential and has given high returns on investment. It is best suited for investors with a high-risk appetite or even for seasoned investors.

3. Reliance Small-Cap Fund

This is a small cap equity oriented mutual fund, which was launched on 1 January, 2013. It is a fund with high risk and has given a return of 20.22% since its launch.

Returns of Reliance Small Cap Fund

Duration Returns (per annum)
1 year  9.9%
3 years  21.1%
5 years  36.7%

Key Features:

  • This is a 5-star rated fund by Groww.
  • It has an AUM of ₹ 6,944 Cr approximately
  • Age is nearly 7 years, so its performance can be easily judged.
  • Has consistently outperformed its benchmark S&P BSE Small Cap since its launch.
  • You can invest in this fund with a minimum SIP of ₹100.

What Exactly is a Small-Cap Fund?

In small cap funds, a large portion of the investment is done in companies that are small in size or have a small capitalization.

Most small-cap funds invest around 60-90% in small caps and the rest in mid-caps and large caps to provide some stability to the investment.

Mutual fund houses offering small-cap funds have professional fund management teams that have the requisite expertise in selecting the right amount of equity in each and every portfolio.

The success of these funds depends on the amount of time invested by fund houses in researching and finding the right dark horse stocks in the small-cap segment.

Over the last one month, small-cap funds are down by 8%. But do not forget that in 2017, they were up by 55%.

Not only that, in terms of 10-year returns, small-caps are definitely the best performing funds.

Conclusion

There are a lot of factors you should take into consideration before selecting a mutual fund scheme that matches your investment goals.

Mutual fund investors in India may disagree on strategies and fund choices. But one of the few things that most would agree on is that investing for the long-term is an ideal method to maximize potential gains and reduce risk.

Read More: 10 Secrets Only Successful Mutual Fund Investors Know

Investing in mutual funds online is very simple and paperless. Simply log in to your Groww account, choose a fund, and invest using net banking – exactly like you would when shopping online.

Also Read: Why Investing in Small-Cap Mutual Funds Through SIP is Right for You

Happy Investing!

Disclaimer: The views expressed in this post are that of the author and not those of Groww.