Small-cap companies do not have any set definition. Typically, a company with a market capitalisation of less than Rs. 5,000 crore falls under a small-cap company. Funds dedicated to investing in such small-cap companies are called Small Cap Funds. Stocks beyond the 251-rank fall under Small Caps.
Small-Cap Mutual Funds mandatorily invest 85% of their corpus in them. They have grown and combined to form an Asset Under Management of Rs. 99,000 crore, as stated by AMFI. Almost every fund has outperformed Large-Cap Funds on average.
How do we determine their suitability?
These small-cap stocks offer much-needed risk diversification in portfolios dominated by large-cap and index companies. Among the best Small Cap Mutual Funds to invest in, your manager allocates your money to companies from different industrial sectors like IT, banking and finance, automotive, FMCG, and more. They are less correlated to index stocks, making them a better diversification bet. Consider these factors while determining their suitability:
Risk appetite
Small-Cap Funds suit aggressive investors with a long-term horizon and a higher risk appetite. If you want better potential returns over the long run, you can consider investing in them. These are also highly volatile during any market scenario and are affected easily by changes in AUM and other factors.
Small exposure
The best Small-Cap Mutual Funds suit investors with an appetite for portfolio value fluctuations, so having only a small exposure to them is best. You may benefit from investing in them through the Systematic Investment Plans, where the rupee cost averaging works in your favour and reduces the overall holding costs. You can also invest in them using the lumpsum method.
Equity exposure
Most small companies take time to witness significant growth and achieve economies of scale. Depending on your investment horizon, this period differs between five to seven years. Ensure that these Small-Cap Funds are not more than 10% to 15% of your Equity exposure, and they fit into your long-term goals.
Other important points
Liquidity is a challenge when allocating Small-Cap Funds. Since these are highly risky and volatile, you should ensure only a small part of your allocation to maintain the balance and avoid overexposing to Small-Cap risk. Also, check the fund composition before investing in them. For instance, you can check the past performance of the DSP Small-Cap Fund and analyse whether it is suitable for achieving your financial goals.
Final thoughts
Mutual Fund selection involves selecting the category and the scheme that suits your goals and risk appetite. Checking the fund type, its performance, and the track record of the AMC and fund managers are a few factors to remember. Additionally, consider the tax implications of all fund categories, depending on the long- or short-term gains.
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