This question is becoming increasingly common these days. People are wondering if they should stop their SIPs in small-cap funds.

Small-Cap Funds are high-risk and high-return funds. They invest in listed companies with a comparatively smaller market capitalization and a high growth potential.

In the year 2017 alone, BSE Small-Cap index gave mind-boggling returns of 60%. In comparison, BSE mid-cap index and Nifty 50 index gave returns of 48% and about 30%.

The potential growth of a small-cap stock is huge. However, at the same time, the risk of volatility is also high.

In case of an adverse event, small-cap stocks demonstrate high volatility. With the stock prices diving down at the blink of an eye, the investor’s money is at high risk in this category.

In 2018, the bull period of the previous year led the way for a bear period and all hell broke loose. With falling prices, the investor’s confidence reached an all-time low. Small-cap stocks and mutual funds were affected the most.

This year, BSE Small-Cap index has fallen from 20,000 points to almost 16,000 points. To categorize this index in % terms, the index has witnessed immense volatility and decreased more than 20% in less than 6 months.

In March 2018, the NIFTY Small-cap index fell from 6.76% to 3.60 %. Moreover, the NIFTY small-cap index P/E has fallen from a 3-digit figure of 110 to 62 in the last 6 months.

While high returns in 2017 have attracted investors to be a part of the small-cap rally, this heavy decline in 2018 is an investor’s worst nightmare.

Historically, small-cap stocks have underperformed whenever a recession has hit the economy

In this scenario, what should a common investor do?

Top small-cap mutual funds such as Reliance Small-cap fund, HDFC Small-cap fund, SBI Small-cap fund, and others have lost their heat and have performed relatively bad.

Which is why it is very common to hear questions like: ‘Should I stop my SIP in Reliance Small Cap Fund? Should I stop my SIP in HDFC Small Cap Fund? Should I stop my SIP in SBI Small-Cap Fund?’

What Is the Way Ahead?

Small-caps, by their very nature, are volatile with a high-risk and high-return trade-off. Recently, the market has been undergoing a bearish phase. Small-cap stocks, in general, have been falling as well.

In order to objectively analyze the scenario, investors must remain invested in small-cap stocks, because it is important to analyze the market downturn as a whole.

With respect to the domestic and global market scenario, the commodity prices in general and crude oil prices, in particular, are volatile and rising. Political uncertainty is prevalent in both domestic and global markets

There is a lot of hue and cry regarding the general elections in 2019, which are less than a year away. The uncertainty over who will form the government is giving rise to investor skepticism. Similarly, uncertainty also prevails the international economy.

It is expected that the present state of affairs are not likely to change drastically over the next couple of quarters. Therefore, the performance of small-cap mutual funds in general and small-cap index, in particular, is expected to follow the above suit.

What to do?

Investors who are not comfortable with the volatility would be better placed investing their money in large-cap and/ or mid-cap funds in the wake of lower volatility and greater stability. Investors may also consider reducing their risk significantly, by opting for multi-cap funds.

Market corrections are a natural phenomenon and they take place from time to time. When you look at the longer investment horizon, such fluctuations get ironed out and wealth is created for investors. Therefore, investors must not try to time the market and it is suggested that they remain invested for the long-haul.

Small-cap mutual funds have historically behaved in a similar manner. In bearish markets, they are the ones to suffer the most.

If you can tolerate the risk, you can choose the option of Systematic Investment Plan or SIP. It will turn out to be a better option, rather than lump-sum

3 Top Small Cap Funds and Their Performance

1. Reliance Small-Cap Fund

The primary investment objective of the scheme is to generate long-term capital appreciation by investing predominantly in equity and equity related instruments of small cap companies and the secondary objective is to generate consistent returns by investing in debt and money market securities.

This small-cap fund by Reliance Mutual Fund house has been one of the best performing funds in this category. It has a decent record of 11.9%, 21.0% and 36.0% for 1-year, 3 years and 5 years respectively.

However, being a high-risk fund, its performance has been volatile. The market downturn has led to an almost 20% dip in the returns of this fund. The NAV of this fund has fallen from Rs.52 to Rs.42.

This is a significant drop for the fund in less than a year’s time.

The fund has performed well in the bull market, however, it has witnessed extreme volatility in the bear market.

2. HDFC Small-Cap Fund

The investment objective of the scheme is to generate long-term capital growth from an actively managed portfolio of equity and equity-related securities.

This small-cap fund has been one of the best performers in this category and enjoys a 5-star rating by Groww. It has delivered high returns of 19.8%, and 20.5% for 1 and 3 years respectively.

The returns have been volatile for 6 months and the market downturn has eroded almost 10% of the returns. The NAV dropped from Rs.70 to Rs.55 in a year’s time. Similar to the other funds in this category, this fund has performed well in the bull market, but not the bear market

3. SBI Small-Cap Fund

The scheme seeks to generate long-term capital appreciation by investing in a diversified portfolio of predominantly equity and equity-related securities of companies identified as industry leaders.

This small-cap fund by SBI Mutual Fund house enjoys a 5-star rating by Groww. It has been one of the best performers in the small-cap category and has delivered a return of 16.4% and 20% in 1 and 3 years respectively.

The recent market downturn has wiped off more than 20% of the returns of this fund. The NAV dropped from Rs.70 to Rs.55 in a year’s time. 

You can read the comparison between Reliance Small-cap fund and SBI Small-cap fund here.

What are Small-Cap Stocks?

According to SEBI, those stocks which are listed from the 251st company onwards, in the order of full market capitalization are known as small cap stocks

Similarly, large-cap funds are from the 1st -100th  and next 150 companies respectively based on full market capitalization.

By nature, small-cap stocks are generally young listed companies with significant growth potential. Due to the above reason, these stocks tend to be more volatile and therefore have a higher risk as compared to mid-cap and large-cap stocks.

To know more about the best mutual found, you can check out the following link: 30 best funds to invest in 2018.

Happy investing!

Disclaimer: the views expressed here are of the author and do not reflect those of Groww.