What are the advantages and disadvantages of small cap funds?

Pijush Kanti Biswas

In small cap funds, a large portion of investment is done in companies with small market capitalization i.e. having a market cap of less than INR 500 crore. Most of small cap funds invest around 60-90% in small caps and rest in mid-caps and large caps to provide some stability to the investment.

Advantages of small cap funds:

1. Small cap fund have exponential growth potential and give high returns on investment if right stocks are picked from small cap segment.

2. Small cap stocks provide good room for diversification in fund’s portfolio as during the investing periods it often happens when large cap stocks don’t perform and small cap stocks grow quickly.

3. They are underfollowed in stock market and usually untapped by institutional investors, giving a huge opportunity to wise investors to grow their investment quickly.

Disadvantages of small cap funds:

1. Small cap funds are highly risky and volatile investment instruments as compared to large and mid-cap fund category due to their exposure in high performing equities.

2. These funds are not suited for all investors. Small cap funds are best suited for investors with high risk appetite or for seasoned investors.

3. Success of these funds depends on the amount of time invested by fund house in researching and finding the right dark horse stocks in small-cap segment. So, selecting right fund house with shrewd fund manager is the key.

4. It is hard to find dividends among small cap funds though a lot of small cap companies do pay dividend.

5. Timing of buy and sale of these funds is very critical.

If you a beginner to investment in mutual funds, especially in equity mutual fund, thinking of the small mutual funds may not be the best idea for you. These are best for investors who have very good ideas of mutual funds and the risks associates with them.

Happy Investing!


Advantages of small cap funds are:

  • 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 funds are:

  • 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.


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