A small cap mutual fund is a type of equity mutual fund that invests a massive portion of its investible amount in small-cap companies. As per SEBI (Securities & Exchange Board of India), a small-cap fund must invest at least 80 per cent of its overall investments in small-cap firms. Note that small-cap firms or companies are those with a rank of below 250th in market capitalisation. In the financial language, these companies are those with a market capitalisation of below Rs 500 crore.
It is a must for you to know that small-cap funds come with a high risk level. Even the slightest amount of market volatility can have a massive impact on small-cap companies’ share prices. However, such stocks even hold a high potential to generate high returns.
Generally, many financial advisors recommend dedicating around 10-20 per cent, i.e., a small percentage of your investment portfolio towards a small-cap mutual fund. This is specifically because stocks in such funds have the potential to generate massive returns. It is very important for you to remain patient when invested in a small-cap fund. Remember that small companies require considerable time to become the next big corporation and assist you to earn huge returns on your investment.
Selecting the correct small-cap fund can be tough and hence it is important for you to conduct prudent research before you invest in them. Discussed here are some of the important factors you must consider zeroing in on for a prudent small-cap mutual fund investment
- Performance vs. benchmark indices and peer funds
Select the small-cap mutual fund that has registered high performance consistently across all market cycles with appropriate risk-adjusted returns. Ensure to select a fund that has consistently outperformed its benchmark indices considerably. Note that a constant outperformance of 3-5 years is looked upon as good.
Also, ensure to compare the small-cap fund’s performance with its category average. This is the best indicator to understand the fund quality. Typically, a good small-cap fund scheme will beat its category average.
- Fund management
You must evaluate the fund manager’s performance and if the manager has delivered a good return constantly over the past 3-5 years. Also, it is essential to review how long the manager has been managing the fund, i.e., the manager’s experience. Constantly good performance of the fund across distinct market cycles is basically a mark determining effective fund management.
- Investment goal
When investing in small-cap mutual funds, your investment goals and objectives can serve as a guiding factor. Ensure that your goals are in alignment with the objectives of the fund. Any deviation may lead to unplanned exits or unnecessary anxiety. This usually may happen during heightened volatility. So, before you invest in a small-cap fund, ensure to be clear regarding what you want. In this manner, you will be sure about your choice and tend to stick with it. You can use this online systematic investment plan calculator to calculate your returns.
Ending note
So, if you are an investor with a high-risk tolerance level who is aggressive on equity investments, then a small-cap fund is one of the best avenues you may consider. However, before this, you must factor in the above-mentioned 3 points to make an informed decision. Also, remember as these funds are sensitive to market volatility, they are the worst impacted when the market slumps. Hence, it is a must for you to eye for a long-term horizon when investing in small cap. Doing so would give adequate time to your small-cap investments to generate high returns. Usually, it is recommended to patiently stay invested for over 5 years in any small-cap fund.
