What Are Small Cap Mutual Funds?
Small-cap mutual funds are funds which invest in start-ups or firms in the process of development that have a market capitalisation of less than Rs 500 crore.
Chances are you have seen a few mutual fund advertisements on TV. You may have even heard the terms 'small-cap funds', 'mid-cap funds', and 'large-cap funds'. These mutual funds are categorised by their market cap. Small-, mid-, or large-cap is not the size of the mutual fund. Here ‘cap’ is indicative of the size of the companies in which the mutual fund invests.
Small-cap mutual funds are funds that invest in companies with smaller capitalisation. These companies have a market capitalisation of less than Rs 500 crore.
(Read more: What is a mutual fund?)
Small-cap mutual funds are funds that invest in companies with smaller capitalisation. These companies have a market capitalisation of less than Rs 500 crore.
Characteristics of small cap mutual funds
They invest in small-cap companies. These include start-ups or small-revenue companies that are in the early stages of development.
The companies that small-cap mutual funds invest in have a high potential for growth in the future.
Small-cap funds are volatile in nature. This is because small-cap companies are not financially stable. They are also not as established as larger firms.
Small-cap funds are risky. They can generate fantastic returns for investors looking for aggressive growth and who possess high risk-taking capacities.
Small-cap funds outperform mid- and large-cap mutual funds during a bull market. A bull market is when share prices rise, which encourages buying.
The performance of small-cap funds decreases much more than mid- and large-cap funds during a bear market. A bear market is when share prices drop, which encourages selling.
Points to remember before investing in small cap fund
Your risk appetite:
Small-cap mutual funds suffer from high market risk. Any changes in the market will reflect in a change in the fund’s net asset value (NAV). When the market as a whole is not performing well, small-cap funds tend to suffer. In times of market instability, smaller and less-established companies may go out of business. On the other hand, when the market is doing well, small-cap funds have a great ability to produce greater returns than other mutual fund types. If you as an investor have a high risk appetite, you can opt for small-cap funds.(Read more: What is NAV?)
Your investment returns:
Small-cap mutual funds have done well in recent years in the Indian market. If you can tolerate risk and want investments that show aggressive growth, then small-cap mutual funds are for you. These funds have the potential to give returns of over 100% in a single day.Your investment horizon:
Small-cap funds face a significant decrease in returns when the market is on a downswing. So, to generate good returns, you should have a long-term investment horizon. This means that your investment should last for seven to 10 years. Historically speaking, small-cap mutual funds deliver higher returns when you have a long-term investment plan.Your financial goals:
Small-cap mutual funds invest in companies that have a high potential for generating great returns. So, if your risk-appetite is large, small-cap funds may be ideal for you. It would be a good idea to have some long-term financial goals in mind when investing. Your financial goals could be saving for retirement or paying for your children’s education, and so on.Taxation:
You earn capital gains upon redeeming units on small-cap mutual funds. Capital gains attract taxation. But the rate of taxation depends on your period of investment in the fund. This is the holding period. Capital gains earned during a holding period of up to 12 months are short-term capital gains. They attract 15% tax. Long-term capital gains are gains earned on a holding period of over 12 months. Long-term capital gains of over Rs 1 lakh have a taxation rate of 10%.How to reduce risk in small cap funds investment
Spend time researching small-cap funds. Funds with a proven record of over five years are good.
Diversify your portfolio so that your losses are minimal when the markets are low. A healthy mix of investments will act as a buffer against a big loss. You may even get good returns in other areas of investment when small-cap funds fail to deliver profits.
Avoid trying to time the market, as it is risky and unreliable. Predicting the market is extremely difficult. If you go wrong in your predictions, it could lead to losses.
Don’t buy or sell in a hurry because of market gains or losses. Both short-term gains and losses in small-cap mutual funds could be temporary. Invest for the long term to overcome market instability.
Try to go for reliable no-load mutual funds. ‘No load’ mutual funds are funds without any commission or sales charge. It may be difficult to find such funds but it is worth a shot.
Invest in small-cap mutual funds through a systematic investment plan (SIP). It will average out the cost, thus reducing volatility. (Read more: How to start an SIP investment?)
WHAT NEXT?
We are almost at the end. Before you start investing in mutual funds, there are a few more important points to keep in mind like taxation. This can affect your total financial returns. To know about these factors, Click here
- Snapshot of profit/loss
- Reflects performance of your portfolio
- Helps compute taxes
