What are small cap funds, its features, and benefits?

For investors seeking a high-growth potential, venturing into the world of small cap mutual funds can be an exciting option. However, understanding the unique features, benefits, and risks of small cap funds is crucial for informed decision-making.

So, let us try to understand and navigate the exciting world of small-cap funds.

• Table of contents

1. What are small cap mutual funds
2. Features of small cap mutual funds
3. Benefits of small cap fund
4. Important considerations
5. FAQ

What are small cap mutual funds?

Small cap mutual funds are essentially equity funds that allocate a significant portion of their funds to stocks of small companies. The Securities and Exchange Board of India (SEBI) establishes the list of top companies and sets the norms for the investment portfolios of various types of funds. According to SEBI, small cap stocks are those that are ranked 251 and beyond based on market capitalisation. Fund managers actively seek out these small-capitalisation stocks, which have the potential to outperform benchmark indices and large cap stocks.

Investing in stocks with the potential to become significant players in the future and generate favourable returns is a key strategy for small cap fund managers. Consequently, investors in small cap funds have the opportunity to capitalise on the growth potential of smaller companies, diverging from the strategies of institutional and large-cap investors.

In bull markets, small cap funds can outperform large cap or mid cap funds, as smaller companies have the room to realise their full potential, leading to a relatively better return potential.

Features of small cap mutual funds:

SEBI mandate: Small cap funds must invest more than 65% of the fund corpus in small cap stocks

High growth potential: Small cap companies, driven by innovation and adaptability, offer the potential for explosive growth, outperforming larger, established firms in favourable market conditions.

Higher volatility: As emerging entities, small cap companies are more susceptible to market fluctuations, leading to potentially higher upswings and downswings in their stock prices.

Diversification: Investing in a small cap fund offers exposure to a diversified basket of potential young companies, spreading your risk and potentially boosting your portfolio's return potential.

Long-term focus: Due to their inherent volatility, small cap funds are suited for investors with an extended investment horizon (ideally 5 years or more) who can ride out market fluctuations and reap the potential rewards of long-term growth.

Active Management: Small cap funds rely heavily on the skill and expertise of fund managers who identify and invest in the good potential small cap companies. This requires careful research and selection.

Benefits of small cap fund:

Returns: Over the long term, small cap funds have historically delivered higher returns compared to their large cap counterparts, making them suitable for growth-oriented investors.

Beating inflation: The high growth potential of small cap companies can potentially outpace inflation, preserving your purchasing power over the long term.

Early access to emerging stars: Investing in small cap funds allows you to gain early exposure to potentially high-growth companies before they become established giants, maximising the return potential.

Portfolio diversification: Adding small-cap funds to your portfolio diversifies your overall holdings. While large caps can provide relative stability, small caps allow you to harness the growth potential of businesses poised to take off.

Important considerations:

High risk:Remember, small-cap investments come with inherent risks due to their volatility and uncertainty. Be prepared for potentially significant short-term fluctuations in your investment value.

Long-term investment: Do not invest in small cap funds with a short-term outlook. These funds are suited for those who can ride out market volatility and focus on long-term growth potential.

Active management: Choose a small cap fund with a proven track record and a skilled fund manager who demonstrates expertise in identifying and investing in potential and exciting small cap companies.

Capital growth: Invest in small cap funds for potentially significant capital growth in the long run. These funds focus on growth opportunities by diversifying and balancing your portfolio.

Conclusion

Small cap funds offer a thrilling entry point to the world of potentially exciting returns. However, their inherent risks and volatility demand careful consideration and thorough research. By understanding features and benefits of small cap funds, assessing your risk tolerance, and practising smart investment strategies, you can harness the power of small cap mutual funds to unlock a rewarding investment journey. Remember, always invest with a long-term perspective and a sound approach to risk management.

FAQs:

Are small-cap funds suitable for everyone?
A: No, small cap funds are not for everyone. Their high volatility and risk profile make them suitable for investors with a high-risk tolerance and a long-term investment horizon.

How much should I invest in small cap funds?
A: The amount you invest in small-cap funds should be based on your individual risk tolerance and overall portfolio allocation. It's generally advisable to limit your exposure to small cap funds to a smaller percentage of your portfolio.

Should I invest in a single small cap fund or diversify across multiple funds?
A: Diversifying across multiple small cap funds with different investment styles and industry focuses can help mitigate risk and potentially enhance your long term returns.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.