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Here’s Everything You Need to Know About Small Cap Mutual Funds
Posted on Tuesday, March 18th, 2025 | By IndusInd Bank
Many of the major companies we know today started out small and took time to achieve their success. In their initial stages, these companies often faced considerable ups and downs as they navigated their path to growth. In the world of stocks and mutual funds, people know these fledgling businesses as small-cap companies.
One can invest in these enterprises through small cap mutual funds. In fact, many investors invest a small portion of their total funds in small cap mutual funds to earn high returns on their overall investment portfolio.
You might be wondering why these tiny companies are so intriguing. Well, it is because they often have plenty of room to grow. Imagine this: in the last 5 years, small cap funds have given an impressive 31% CAGR!
To put it simply, if you had invested ₹10,000 five years ago, it could have grown to over ₹38,000 today. Sounds amazing, right? But remember, with the potential for high returns comes a bit more risk. Let us dive deeper and explore if small cap mutual funds are the right fit for your investment goals.
Also Read: What is SIP?
What are Small Cap Mutual Funds?
Small cap funds are mutual funds that primarily invest in stocks of small cap companies. These companies are characterised by their relatively small market capitalisation, typically under ₹5,000 crores in India.
Features of Small Cap Mutual Funds
Before diving into small cap funds, it’s crucial to understand what they bring to the table:
High Risk
Small cap funds come with a high level of risk. While they have the potential for impressive growth and returns, it’s important to remember that these companies aren’t as stable or resourceful as their larger counterparts. This vulnerability makes them more susceptible to negative events and bearish market trends.
Diversification
Even if you’re not a high-risk investor, adding small cap mutual funds to your portfolio can offer valuable diversification and balance. Large cap and small cap funds sit at opposite ends of the equity mutual funds spectrum. Including both in your investment mix is a strategic move to safeguard your investments.
When the market devalues small cap funds, the stability of large cap funds offsets the impact. Similarly, if large cap funds underperform, the high returns from small cap mutual funds can provide a counterbalance.
Advantages of Small Cap Mutual Funds
Small cap mutual funds come with a set of unique advantages that can make them an attractive option for investors seeking growth potential. Here are some key benefits:
| 1. | High Growth Potential | Small cap companies often have significant room for growth. As these companies expand and mature, their stock prices can increase substantially, offering the potential for impressive returns. |
| 2. | Opportunity to Invest Early | Investing in small cap mutual funds allows you to get in on the ground floor of companies that could become tomorrow’s market leaders. Early investment in these companies can lead to substantial gains if they achieve success. |
| 3. | Higher Returns | Historically, small cap stocks have outperformed their larger counterparts over the long term. While they come with higher risk, the potential for higher returns can be appealing to investors with a higher risk tolerance. |
| 4. | Less Analyst Coverage | Small cap companies often receive less attention from analysts and institutional investors compared to large cap companies. This can create opportunities for individual investors to identify undervalued stocks and benefit from their growth. |
| 5. | Active Fund Management | Many small cap mutual funds are actively managed, meaning fund managers make strategic investment decisions to maximise returns. This active management can help navigate the volatility and opportunities within the small cap space. |
How do Small Cap Mutual Funds Work?
Small cap mutual funds work by pooling money from multiple investors and using that collective capital to invest in small cap stocks. Here’s a breakdown of how they operate:
- Pooling of Funds: Investors contribute money to the mutual fund, which pools all the contributions together. This pool of funds is managed by a professional fund manager.
- Investment in Small Cap Stocks: The fund manager uses the pooled funds to buy shares in small cap companies. These companies are typically characterised by their small market capitalisation, usually under ₹5,000 crores in India.
- Diversification: The fund manager diversifies the investments across various small cap companies and sectors. This diversification helps spread the risk and potential returns across different investments.
- Active Management: The fund manager actively monitors and manages the portfolio, making buy or sell decisions based on market conditions, company performance, and other relevant factors. The goal is to maximise returns while managing risk.
- Performance Monitoring: The mutual fund’s performance is tracked and reported regularly. Investors can see how their investments are performing and make informed decisions based on the fund’s track record and market conditions.
- Dividends and Capital Gains: If the small cap companies in the fund’s portfolio perform well and generate profits, the fund may distribute dividends to investors. Additionally, if the value of the stocks increases, investors can benefit from capital gains when they sell their mutual fund units.
- Fees and Expenses: Investors should be aware of the fees and expenses associated with small cap mutual funds, such as management fees, administrative costs, and other charges. These fees can impact the overall returns of the investment.
- Redemption: Investors can redeem their mutual fund units when they wish to exit the investment. The redemption value is based on the fund’s Net Asset Value (NAV) at the time of redemption.
Also Read: What is SWP?
Who should Invest in Small Cap Mutual Funds?
Investing in small cap mutual funds can be a rewarding experience, but it’s not for everyone. Here are some types of investors who might find small cap mutual funds a good fit:
- Growth-Oriented Investors: If you’re looking for high growth potential and are willing to take on more risk, small cap mutual funds can be a great option. These funds can offer significant returns over the long term as small companies grow and expand.
- Long-Term Investors: Small cap stocks can be volatile in the short term, but they often perform well over the long term. If you have a long investment horizon and can ride out market fluctuations, small cap mutual funds might be suitable for you.
- Diversification Seekers: Adding small cap funds to your portfolio can provide valuable diversification. If you’re looking to balance your investments across different market capitalizations and sectors, small cap funds can help achieve that.
- Experienced Investors: Investors who have a good understanding of the stock market and are comfortable with higher risk might find small cap mutual funds appealing. These funds require a higher risk tolerance and a keen eye on market trends.
- Investors with Higher Risk Tolerance: If you’re not risk-averse and are prepared for the ups and downs of the stock market, small cap mutual funds can offer attractive growth opportunities. However, it’s essential to be ready for potential volatility.
- Investors Seeking Undervalued Opportunities: Small cap companies often receive less attention from analysts and institutional investors, which can lead to undervalued stock prices. If you have the ability to identify and invest in these opportunities, small cap mutual funds can be beneficial.
Wrapping Up!
By now, you must have understood that small cap mutual funds offer a unique investment opportunity with the potential for high returns and significant growth. They can be a valuable addition to a diversified portfolio, especially for those willing to embrace a bit more risk for the possibility of greater rewards. However, it’s crucial to understand the associated risks thoroughly and have a long-term investment horizon.
Whether you’re an experienced investor looking for undervalued opportunities or a growth-oriented investor eager to invest early in promising companies, small cap mutual funds could be a compelling choice. Always consider consulting with a financial advisor to tailor your investment strategy to your specific needs and goals. Happy investing!
