Top 10 Small Cap Mutual Funds

Equity Small cap funds invest in the companies that are very small in the market but have a potential to favor attractive returns. This fund also holds the companies that have smaller market capital. It has returns that are taxed at 15% if sold before one year, post this period a 10% tax is applicable on the gains

A small cap fund is a category of mutual fund which looks for opportunities in small cap stocks trading on BSE and NSE. Small cap funds are characterized as high risk high return funds. These funds give the highest level of return within the equity fund category. A tenure of approximately 5 years is considered as a safe investment in these funds.

Stocks in these funds are high beta stocks which means their response is very high to stock market movements. Because of these stocks the volatility of a small cap fund increases and makes a small cap fund highly responsive to changes in the market. A fund may not invest the entire part of the investments in small cap stocks and may diversify by investing a small portion in mid cap or large cap stocks. This portion may vary from fund to fund or from time to time.

Also, these funds are not suitable when the tenure of investment is short as these might give losses in the short run due to frequent changes in the stock markets because of the fluctuations in the business cycles but in the long term they give higher returns as the stocks in these funds turn into large companies over time. An investor can choose to invest either in lump sump amounts or through monthly SIPs.

Purpose: Recommended only for long term investing. These funds can be clubbed with low risk – low return funds to average out your portfolio risk and return.

Advantages of Small Cap Funds

Higher growth potential- One of the major benefits of small cap funds is the growth potential they offer. Small cap companies offer a greater growth potential than larger companies since these larger companies have already achieved most of their growth. Flexibility- These smaller companies tend to be more flexible than larger companies and hence can adapt to changes more easily and quickly. Focus- Small cap companies tend to be more focused than large companies due to their size and age. As most of these haven't yet expanded into various different lines of business they aim to grow in their current business lines. Potential for undervaluation- Since these small cap companies are relatively new and unknown and usually have low levels of equity research coverage, they have a higher chance of being undervalued and get you a greater discount.

Disadvantages of Small Cap Mutual Funds

Low liquidity- Even though small cap funds offer a greater growth potential, they have low liquidity which reduces their usability. Market Fluctuations- A lot of these smaller companies can be highly volatile and hence are tend to have large up and down movements. High Risk- Small cap funds have higher opportunities of growth but these come with higher amount of risk as well. Therefore, these are suitable only for those investors who have higher risk appetite. Less dividends- Since small cap companies are fast growers they tend to retain all profits to reinvest them in the company. This leads to reduced dividends for investors.

How do small cap mutual funds work?

Small-cap funds have are high returns funds. In this article, there are 5 best small- cap funds for 2018. As with any high-returns fund, the risk is high too. But if you invest for the long-term – at least 6 years, these funds can offer exceptional returns. Investing in small-cap funds for a period less than that is too risky. However, each person’s financial status is different. Based on that, you can wary your investment amount and risk-taking ability. If you look at the market since January 15, 2018, one thing that emerges quite evidently is that the bull-run in the small-cap and mid-cap category came to an end and there has been a clear trend reversal with large-caps taking the growth lead.

Who should invest in small-cap mutual funds?

Every investor has an area of specialization. For example, if you are working in the steel industry, then your fundamental understanding of the steel industry will be much stronger and that will work to your advantage. You will be a good judge of when steel companies are doing well and when they are lagging. You can argue that steel companies are large and they cannot fit into a small-cap portfolio. That is absolutely fine! If steel companies grow, then you will need more electric arc furnaces and so, graphite companies will benefit. These are small cap stories. In volatile times, the best hedge is to stick to your circle of competence. It not only reduces your risk but also helps you identify interesting buying opportunities.