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Small-Cap Mutual Funds

When talking about Equity Mutual Funds, it is important to understand the market capitalization of companies. In simple terms, market capitalization is the value of the company which is traded on the stock exchange. The calculation is simple – you multiply the present share price by the total number of outstanding shares. It is an important aspect that can help investors determine the returns from a share and the risks involved.

Based on market capitalization, mutual fund schemes are categorized as large-cap, mid-cap, small-cap, and multi-cap schemes. Here, we will explore Small Cap Mutual Funds and discuss various aspects you need to know before investing in them.

List of Small Cap Mutual Funds

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What is Small Cap Funds

Small-cap funds invest a major portion of their investible corpus into equity or equity-related instruments of small-cap companies. According to the Securities and Exchange Board of India (SEBI), small-cap schemes need to invest at least 80% of their total assets in small-cap companies. Also, SEBI defines small-cap companies as those that are ranked below the 250th rank in terms of market capitalization. In monetary terms, these companies have a market capitalization of less than Rs. 5000 crores.

It is important to note that small-cap funds carry a high level of risk. Even the slightest volatility in the market can have a huge impact on the share prices of small-cap companies. However, these stocks also have a vast potential to offer incredible returns. Think about it – a small company has a lot of scope for growth, and when it does grow, the share price will increase dramatically. 

However, many investors turn to small-cap schemes for short-term investment needs. This can be counterproductive as small companies need time to grow. Hence, people usually opt for small-cap funds if they have a higher risk tolerance and a long investment horizon.

Features of Small Cap Equity Funds

The major features of a small-cap fund are:

  1. Investment Horizon

Small-cap stocks are highly sensitive to market movements. Therefore, when the market slumps, these stocks are probably the worst affected. Hence, it is important to have a long-term investment window while investing in Small-Cap Funds so that you give sufficient time to your investment to generate returns. The recommended time frame is eight to ten years. Making these funds highly suitable for long-term investors. 

  1. Risk Tolerance

Small Cap Funds offer great potential to earn benchmark-beating returns. These are highly risky investments and should be considered when you can stomach the price volatility. Further, you can dedicate a small portion of your portfolio to small-caps and stay invested for a long period to boost your wealth creation efforts.

Mentioned above are the primary characteristics of a small-cap mutual fund.

How Does a Small Cap Mutual Fund Work?

Fund managers in small cap equity funds spend at least 65% of their holdings in small-cap equities. Small-cap companies are typically selected by investors who are willing to take chances and prefer positive returns over stability. Small-cap funds rely heavily on fund composition, and rash selections can jeopardize your investment.

One of the important elements in determining what to put in the equity portfolio is the capitalization of the investing company. Small-cap funds invest in all companies whose market capitalization is estimated to be in the top 250. 

In the short to medium term, these funds are riskier and more volatile than other equity-focused funds, but they offer larger long-term returns. These companies' shares can quickly double or triple in value. However, like with most market investments, risk is always present.

How Should You Invest in a Small Cap Mutual Fund?

You can invest in Small Cap mutual funds either directly through the issuing company. Alternatively, you can also choose Groww's application to start investing in Small Cap mutual funds online. 

Step 1: Visit the app or Play Store. 

Step 2: Download the Groww application - and sign up. 

Step 3: After the sign up through KYC, you can start investing in small-cap mutual funds. 

Why Should You Invest in a Small Cap Fund?

Small Cap mutual funds carry many advantages to their investors, such as:

  1. High Returns: Small Cap mutual funds have the potential to provide significantly higher returns than mid-cap or even large-cap funds. This is due to the strong growth potential of these companies. 
  1. Low NAV: The Net Asset Value (NAV) of Small Cap mutual funds is typically relatively low. This allows you to buy more units, which can boost your returns significantly if market conditions are favourable. 
  1. Diversification Opportunity: You can diversify your financial portfolio by investing in Small Cap mutual funds. This lowers your overall investment risk and boosts your chances of being protected even when the market faces headwinds. 

People who are willing to take some risks in order to maximize their portfolio might consider investing in Small Cap mutual funds. These funds are renowned for providing significant returns when the market is gloomy. However, when the market falls, these funds might suffer severely.

Taxation Rules of Small Cap Mutual Funds

The returns on Small Cap Funds are subject to capital gains tax (for any capital gains made) and Dividend Distribution Tax or DDT (for any dividend received).

Capital Gains Tax

Capital gain is the profit made from selling an investment. Hence, when you redeem the units of the Small Cap Fund and make profits, you are liable to pay capital gains tax. The rate of this tax depends on the period for which you were invested in the scheme – the holding period.

  • If you were invested in the Small Cap Fund for a holding period of less than one year, then the capital gain earned by you is called Short Term Capital Gain or STCG. This is taxed at 15%.
  • If you were invested in the Small Cap Fund for a holding period of more than one year, then the capital gain earned by you is called Long Term Capital Gain or LTCG. LTCG of up to Rs. 1 lakh is not taxed. Any gain above this amount is taxed at 10% without indexation.

Dividend Distribution Tax (DDT)

Before paying out the dividend, the fund house has to deduct a DDT of 10%.

FAQs

Q1. What is Small Cap mutual fund meaning?

Small Cap mutual funds are equity mutual funds that invest in small-cap stocks. Small-cap firms are those with a market capitalization of less than Rs. 5,000 crore.

Q2. What are the main advantages of investing in Small Cap mutual funds?

The primary benefit of investing in a small-cap mutual fund is that it offers exceptional returns (it offers higher than large or mid-cap funds.) 

Q3. What is the major risk of investing in a small-cap fund?

One of the biggest risks connected with small-cap funds is that their prices might fluctuate dramatically. This makes them extremely risky to invest in because the losses can be substantial if the price does not move in accordance with your expectations. 

Q4. Who can invest in Small Cap mutual funds?

Investors who have a high-risk appetite and a long time horizon to invest can choose Small Cap mutual funds. 

Q5. What is the distinction between small-cap versus mid-cap mutual funds?

In India, funds are classified as large-cap, mid-cap, or small-cap based on their market capitalization. Large-cap funds have the greatest market capitalization company stocks, mid-cap funds are in the middle, and small-cap funds have the lowest.

Disclaimer - Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

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