Small-cap stocks are often ignored by many investors because of their high-risk tag. But, there are more to these equity mutual funds beyond this. Read on to know more.
Why you should invest in small-cap funds?
- Returns
It is true that small-caps are most prone to market fluctuations. However, the other side of the coin is that they can generate record-breaking returns. The small-cap mutual fund's category generated an average return of 12.34% in the last year. The benchmark (S&P BSE Small Cap Index) also went up by 10.3%.
- Growth potential
The biggest advantage of these equity mutual funds is their potential for significant upside growth which is unmatched by large-caps. Large-caps are already well-established in their domains (often being the market leaders) and hence have little or no room for growth in stock value. Small-caps on the other hand, are on a fast-paced growth trajectory.
- Size of small-cap universe
There are over 4700 companies in the small-cap universe compared to 100 and 150 in large-caps and mid-caps. This wide range allows you to choose stocks which are suitable for your needs and goals.
- Cost-effective
Large-cap companies usually have a premium valuation due to their market positioning and legacy. Comparatively, small-cap funds are affordable since they are yet to prove their potential. As a result, in the case of right stock selection, the net result from the investment is extraordinary.
Things that you need to keep in mind
- Tip #1: Check the investment horizon
Small-cap mutual funds are extremely volatile, especially in the short-run. You need to have time on your hands (minimum 7-8 years) and patience to get the optimal alpha returns from these investments. Time in the markets is an important factor for these equity mutual funds.
Pro-Tip: While you should not wait for the “perfect” time to make your investment decisions, investment in high potential small-caps, especially during market correction periods, can help in generating more alpha from this category.
- Tip #2: Keep the Portfolio Composition in mind
SEBI mandates that these equity funds need to invest minimum of 65% in small-cap stocks. They can allocate the balance funds across market capitalization segments. Many funds from this category invest the balance in large-cap stocks to hedge against losses in a falling market. It also helps to meet the portfolio’s liquidity requirements.
Pro-Tip: Hence, it is important to analyze the fund’s portfolio composition to check if they have adequately provisioned for different market situations.
- Tip #3: Note the difference between performers and laggards
Last year saw the gap between performers and laggards grow wider in the small-cap category. While the top-performing small cap equity mutual funds generated average returns between 22% to 26%, the bottom-most funds yielded only 2% to 6%.
Pro-Tip: In addition to right stock selection, factors that helped the performers get an edge were higher churn, more cash in the portfolio and smaller AUMs.
- Tip #4: Do a quantitative analysis
Numbers and data points can help to remove subjectivity or emotions from our decisions. Performance history (across market cycles), outperformance (benchmark as well as peers) and financial analysis such as expense ratio (cost-effectiveness), P/E Ratio (growth potential) should be given due weightage.
- Tip #5: Check the qualitative factors
It is important to weigh the quantitative data along with the qualitative factors. Quality of stocks, the credibility of the fund house’s management team and fund managers, research and technical acumen, etc. play an important role in correct fund selection.
Which small-cap mutual funds are going strong?
Here are the five best small cap mutual funds in India:
- SBI Small Cap Fund
|
Launched in |
AUM (Feb end 2020) |
CAGR (since inception) |
|
Sept 2009 |
Rs. 3475.69 Crores |
17.65% (Benchmark-7.62%) |
- Axis Small Cap Fund
|
Launched in |
AUM (Feb end 2020) |
CAGR (since inception) |
|
Nov 2013 |
Rs. 2506.67 crores |
Regular: 21.72% Direct: 23.12% (Benchmark: 10.82%) |
- HDFC Small Cap Fund
|
Launched in |
AUM (March-end 2020) |
CAGR (since inception) |
|
April 2008 |
Rs. 6246.47 crores |
12.16% (Benchmark: 5.28%) |
- Nippon India Small Cap Fund
|
Launched in |
AUM (Feb end 2020) |
CAGR (since inception) |
|
Sept 2010 |
Rs. 8566.82 crores |
15.46% (Benchmark: 4.43%) |
- Kotak Small Cap Fund
|
Launched in |
AUM (Feb end 2020) |
CAGR (since inception) |
|
Sept 2010 |
Rs. 1633.2 crores |
11.35% (Benchmark: 10.87%) |
Final Words
Small too can have potential. Small too can be powerful. If invested wisely, these funds can be the dark horse who wins the race. Just remember it is a marathon and not a 100-meter run. So, have patience and hold onto the reigns.