What is small cap fund?

When mutual funds invests large portion of the investment in companies having small market capitalization, these funds are called small cap funds.

• These funds provide higher returns and high risk exposure to investors.
• They are more volatile in comparison to other categories of funds. They are highly responsive to even small movements in the market.
• Most of the funds invest at least 60% of the capital in small cap companies and rest of the investment in mid cap and large cap companies.
• This diversification can help the investors to minimize the risk exposure.
• They are ideal for investors with high risk appetite and can deliver high returns due to their exponential growth.
• These funds require both time and research of fund managers for proper selection of stocks.
• If you are a beginner to investment in mutual funds, you should opt for mid cap and large cap funds as they are more stable in comparison to small cap funds.

As this funds invest in small and bidding companies, identification of companies having growth potential, diversification become significant. Hence, the role of fund managers in small cap funds is of immense importance.

Top performing small cap funds:

Market capitalisation is an indicator of the size of the company. It is calculated as the number of shares outstanding multiplied by the current market price of one share. For example, if a company has 10,00,000 shares outstanding, each with a market price of Rs. 50, the market capitalisation of that company is Rs. 5,00,00,000.

When a mutual fund describes itself in terms of market capitalisation, it essentially divides its fund into the following three categories:

(a) Large cap fund

(b) Mid cap fund

(c) Small cap fund

On the lowest end of the market capitalisation continuum are small cap funds. Different fund houses have different limits for segregating companies into one of these three categories. So one fund house may include companies with a market cap of Rs. 100,00,00,000 in its small cap fund whereas another fund house may include the same company in its mid cap fund. Over time, these limits may change for the same fund house too.

Though the exact limit may vary depending upon the fund house, the general consensus is that small cap funds invest in start-ups or companies that are in the early stages of development. These companies are identified by fund managers as companies that have high growth potential; therefore investing in these companies may provide high returns if the company performs as per the expectations of the manager. However, in times of market instability, these companies are most vulnerable to volatility and a few less-established companies may even run out of business, thereby leading to decline in the value of investors' corpus.

Small cap funds are better suited to investors who are not risk averse and are looking for aggressive returns. Though the general notion is that small cap funds make for good short term investments, they actually are desirable over the long term too if the company matches up to its growth potential.

It is also important to note that identification of small and budding companies with growth potential is a process that requires great skill and expertise, therefore selecting the correct fund manager is a very important part of investing in small cap funds.

Thinking of investing in an equity mutual fund, it is very crucial to decide on most appropriate market capitalization to choose the fund from – i.e. among large cap, mid cap, small cap, sectoral cap or multi-cap fund category. Each category of market capitalization categories has its own advantages and disadvantages.

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. Small cap funds are highly risky investment as compared to large cap fund category due to their exposure in high performing equities. These funds have exponential growth potential and give high returns on investment and is best suited for investors with high risk appetite or for seasoned investors.

Mutual fund house offering small-cap funds have very professional fund manager team having expertise to select the right equities with optimum diversification in portfolio. 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.

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. To ensure that the fund is in good hands, choose a fund house having fund manager with good amount of experience managing small cap funds and associated with these funds for some good numbers of years.

Happy Investing!

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.