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Small Cap Mutual Funds: What Makes It the Best Option for Portfolio?

Home - Finance - Small Cap Mutual Funds: What Makes It the Best Option for Portfolio?

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Insights into Small Cap Mutual Funds

The Small Cap Mutual Funds are equity funds that invest primarily in stocks of companies with relatively small market capitalizations, typically below a certain threshold set by the fund manager or market indices. These funds offer investors the opportunity for high returns over the long term by investing in small, rapidly growing companies with the potential to become future market leaders.

In this article, investors can get a complete analysis of this small cap category to make an informed decision.

Key Benefits of Investing in Small Cap Mutual Funds

There are multiple benefits offered by this particular category to investors, let us explore some of them:

High Growth Potential

Small-cap companies are often in the early stages of their business and have significant growth potential. As these companies expand, their stock prices can increase substantially, leading to potentially higher returns for investors. The relatively lower starting valuations of small-cap stocks mean there is more room for appreciation as the companies grow and scale.

Diversification                                    

Small-cap mutual funds provide diversification benefits. The small-cap investment universe is larger compared to the large and mid-cap space, allowing these funds to invest in various companies across different sectors. This broad diversification can reduce the risk associated with investing in any single sector or company.

Untapped by Large Institutions

Small-cap stocks are often overlooked by big institutional investors due to their smaller size and liquidity constraints. This lack of attention can leave many small-cap stocks undervalued, providing opportunities for fund managers to identify and invest in high-potential companies that are not yet recognized by the broader market.

Potential for Alpha Generation

Skilled fund managers can generate alpha, or excess returns, by identifying undervalued small-cap stocks with the potential to outperform the broader market. The active management and research-intensive approach required for small-cap investing can lead to superior stock selection and returns.

Factors to Consider When Investing in Small Cap Mutual Funds

The following factors showcase the vital points that should be kept in mind:

Risk Tolerance

Small Cap Mutual Funds, are considered riskier and more volatile compared to large-cap or mid-cap funds due to their exposure to smaller companies. These businesses are typically more vulnerable to economic downturns and market volatility.

Investors should have a high-risk appetite and be comfortable with potential short-term losses.

Investment Horizon

Small-cap funds are best suited for long-term investors with a horizon of at least 5-7 years. It typically takes time for small companies to grow significantly and achieve economies of scale. A longer investment horizon helps investors ride out market volatility and benefit from the compounding of returns.

Portfolio Composition

Before investing, it’s important to thoroughly check the composition of the fund’s portfolio. Investors should assess the fund’s exposure to small-cap stocks, its diversification across sectors, and the experience of the fund manager. A well-diversified portfolio managed by an experienced fund manager can help mitigate some of the risks associated with small-cap investing.

Allocation of Small Cap Stocks

Small-cap funds should constitute a small part of your overall equity allocation, typically not more than 10-15%. This balanced approach ensures that you do not get overexposed to the higher risks associated with small-cap stocks while still benefiting from their growth potential.

How to Invest in Small Cap Mutual Funds?

Investing in small-cap mutual funds is straightforward and can be done through various online platforms. Here’s a step-by-step guide:

Choose an Online Platform

Select a reliable online platform like MySIPonline, which offers user-friendly interfaces and comprehensive fund details.

Create an Account

Register and create an account by providing basic KYC details, including your PAN and bank account information.

Select the Fund

Browse through the list of small-cap funds available on the platform. Evaluate the funds based on their past performance, fund manager experience, and portfolio composition.

Invest

Decide the amount you want to invest and the mode of investment (lump sum or SIP). For SIPs, choose the monthly investment amount and duration.

Make Payment

Complete the transaction using your preferred payment method, such as UPI, direct bank transfer, or debit card.

Case Study: Performance of Top Small Cap Funds

Consider the performance of a few top-performing small cap funds over recent years:

SBI Small Cap Fund: This fund has delivered an annualized return of 25.95% over the past five years, with trailing returns of 39.28% over one year and 22.96% over three years.

HDFC Small Cap Fund: Known for its consistent performance, it has achieved an annualized return of 27.63% over the past five years.

Axis Small Cap Fund: This fund has shown strong returns with an annualized performance of 30.12% over the past five years.

These funds demonstrate the potential for high returns that Small Cap Mutual Funds can offer, especially when managed by experienced fund managers.

Conclusion

To sum up, Small cap funds offer the potential for high returns and diversification, making them a valuable addition to your investment portfolio. However, it is crucial to carefully consider your risk tolerance, investment horizon, and allocation before investing in these funds. By investing in small-cap mutual funds through a systematic investment plan (SIP), investors can benefit from rupee cost averaging, reducing the cost of holding over the long term. For long-term financial goals and wealth creation, small-cap stocks can be a strategic component of a diversified investment strategy.

For more detailed insights and specific fund recommendations, consult financial advisors or utilize trusted financial platforms to tailor your investment strategy to your personal financial goals and risk profile.