Best Small Cap Mutual Funds

Here are some features of small-cap mutual funds: 

Asset allocation: According to the Securities and Exchange Board of India (SEBI) rules, small-cap funds must allocate at least 65% of their investment corpus to small-cap stocks. 

Risk-reward ratio: The top small-cap mutual funds are associated with higher risk levels compared to mid-cap and large-cap funds over the short and medium term. Nevertheless, they can generate substantial returns and even outperform other equity-oriented funds over the long term.

Short-term capital gains tax: If the holding period of the units sold is less than 1 year, the short-term capital gains are taxed at 15%, irrespective of the realised sum. 

Long-term capital gains: LTCG tax of 10% is applicable on gains exceeding Rs.1 lakh if the holding period is more than 1 year. On the flip side, if the cumulative capital gain is within Rs.1 lakh for a financial year, it is tax-free.

Small-cap funds are associated with higher risk when compared with other types of equity funds. The underlying stocks are severely impacted in a bearish market due to small-cap companies’ perceived financial and organisational instability. Thus, these funds may suffer huge losses during a bearish trend. However, in a bullish market, these mutual fund schemes can generate substantial returns and even outperform large and mid-cap funds. That said, they must also consider certain aspects that will help them choose the best small-cap mutual fund scheme.  

Investors must make sure to take the following things into account before investing in small-cap mutual funds: 

Investment goal: When choosing the right investments, there is seldom a “one size fits all” solution. The investment goals and horizons are not the same among all individuals. One person may be looking to invest for 3 years, while another might be ready to earmark their savings for 10 years. The choice of small-cap MF scheme for investor A and investor B will vary accordingly. Hence, investors need to identify their financial objective before investing in any of the best small-cap funds 2023.

Expense ratio: It is the annual fee levied by an Asset Management Company (AMC) on investors. It measures the % of fund assets utilised towards operating and administrative expenses, comprising fund manager’s fee, custodial service fee, legal expenses, etc. This charge differs from one scheme to another. Hence, individuals must consider the fund's expense ratio before allocating their funds to it since it determines the precise % of returns they realise. 

Past performance of the fund: The returns generated by a fund since its inception give an idea regarding the variables that have influenced the same in the past. Hence, it’s an essential factor to consider for investors willing to invest in small-cap mutual funds. However, trailing performance may not be a strict indicator of a scheme’s prospects.

Experience of the fund manager:  A particular scheme’s performance is directly impacted by the decisions of fund managers as they buy and sell securities based on their research and analysis. Thus, it’s crucial to glance through a respective fund managers qualifications and previous performance before investing in small-cap funds.  

Portfolio composition: Although a scheme’s composition can vary going forward, analysing the current holdings can be insightful. It offers a glimpse of the sectors a particular plan is covering presently and the value it can provide. 

Direct or regular plan: A direct plan is offered by an asset management company (AMC) directly. In this case, there is no involvement of a third party, for example, brokers, and distributor, unlike a regular plan. Hence, direct plans have a lower expense ratio. Furthermore, since no brokerage or commission is necessary in direct methods, they report a higher NAV than regular plans.

Here are some of the benefits of investing in the best small-cap mutual funds:

• High growth potential: These funds possess immense growth potential. It’s because small-cap companies have an aggressive expansion strategy that can boost their growth significantly, especially over the long term. 

• Ability to outperform other equity funds: In case the large-cap and mid-cap funds are not delivering returns per expectations, small-cap mutual funds can be a suitable portfolio inclusion. These tend to offer better gains, thus, balancing your portfolio. 

• Researched diversification: The best small-cap mutual funds usually invest in stocks of companies with massive potential to generate returns. Fund managers conduct extensive research to analyse the top-performing stocks and invest accordingly. It lets investors diversify their portfolio but with calculated risk. 

Investment route: Investors can allocate their savings to small-cap funds via two ways: lump sum and Systematic Investment Plan (SIP).  By opting for the first option, individuals can invest the total amount they want to invest in at one go. Nevertheless, please note that one may have to invest a minimum of Rs.1,000 in this case. On the contrary, SIP allows investors to allocate their funds to a mutual fund scheme at fixed intervals (monthly, quarterly, etc.). The instalment amount can be as low as Rs.100 in this regard.