Small-Cap Funds: Meaning, Features & Benefits 

Recently, mutual funds have held their own as investment avenues as they cater to different investor needs. Among the many kinds of mutual funds you get these days, small-cap mutual funds are worth a look. Essentially, these are “aggressive” funds that invest your money in stocks of small-cap organisations. Concerning market capitalisation, small-cap companies fall in the lowest rung of companies, with mid-cap, and large-cap companies, respectively, above small-caps. Small-cap mutual funds are chosen for their potentially lucrative performance in the long term, but they are prone to more risk than other investment alternatives. This is because small-cap stocks are influenced by economic crises and market shifts, considering their low market capitalisation to withstand such shocks.  

Nonetheless, small-cap companies with a market capitalisation of ₹5,000 or less, have more potential for growth in the long haul than established firms with larger capitalisations. It’s a good idea to delve deeper into such mutual funds to  

What are small-cap funds? 

To go into more detail about small-cap mutual funds, you could say that this mutual fund category is made up of the equity of small-cap companies, investing at least 65% of capital in small-cap stocks. The rest of the fund may invest in stocks of mid-caps or debt instruments, but the majority is made up of small-cap stocks. These funds, due to the nature of the major composition of small-cap stocks, tend to be affected by the ups and downs of the stock market, and hence, may be held for long durations to ride the volatility in the market.  

How do small-cap funds work? 

All mutual funds are operated and managed by expert mutual fund managers who allocate your assets to maximise profits with minimal possible risk. A small-cap fund works in a way that invests in the stocks of small-cap companies. Typically, a small-cap fund will invest, at a minimum, 65% of its portfolio in stocks of small-cap companies. Thus, the majority weightage of these funds comprises small-cap stocks.

The appeal of these funds is in the fact they yield high returns relative to other funds, but face more risk as they are affected by market volatility to a large extent. Nonetheless, investors who are willing to tide through volatility in the hope of substantial gains. Furthermore, the structure of small-cap mutual funds is a crucial element of how these funds function. Savvy fund managers choose small-cap stocks very carefully and prudently, laying stress on the firms that don’t fall within their large-cap counterparts. The idea is to select unknown companies, but those that may have a propensity for growth in the future.  

Key Considerations Before Investing in Small-Cap Mutual Funds

For investors willing to take the risks of market fluctuations with the potential of some of the best small-cap funds to provide positive returns, they must consider the following however tempting they find investments:  

Objective of Investment 

If you are interested in the investment of small-cap funds, you must choose funds according to your financial goals and investment timeframe. These funds match investors who don’t mind being patient and holding on to funds for long durations (7-10 years). If your goals are of a long-term nature, like investing for retirement or the higher education of your child, small-cap funds could be a consideration.

Profile of Risk 

Top small-cap mutual funds come with risk, as they have the potential for substantial returns. If you have a risk tolerance and can accept potential risk, then you may consider these funds, as opposed to large-caps offering less risk.  

Risk vs Estimated Return 

When assessing small-cap mutual funds for investment, studying a fund’s past performance may be a way to gauge its potential. However, this is not the only variable to consider. You can also make comparisons of the degree of risk with the possible returns you may get with small-cap mutual funds. It’s wise to study benchmarks and pick funds that have a history of outperforming peers and benchmarks.  

Cost of Investment 

When you go in for any mutual fund investment scheme, certain costs have to be factored in. For instance, mutual fund houses charge a management fee that is termed an expense ratio. It’s important to pick a small-cap fund with a low expense ratio so this does not eat into your potential profits.  

Taxation 

Any investment has tax implications to think about. You must grasp how capital gains tax is applied depending on the duration of investment (holding period). Taxation involves short-term capital gains tax applied to investments held for up to 1 year, and long-term capital gains tax for investments held for more than a year based on certain investment sums.  

Who should consider investing in small-cap mutual funds? 

In case you are wondering whether you are suitable as an investor for small-cap funds, here are some characteristics of investors who may consider investing in these funds:  

Long-Duration Investors: Investment in small-cap mutual funds is suitable for investors who can remain invested for long periods, say, more than 7 years. Across lengthy periods, small caps have the potential to generate significant profits and tide over any market volatility that may occur in the interim.  

Investors Seeking Diversification: If you are an investor looking for ways to diversify your financial portfolio, a small-cap fund may match your requirements. Small-cap mutual funds invest assets in start-ups in a range of industries and sectors. These companies tend to add value to a portfolio as they have growth potential. By spreading your risk with small caps, you can also get exposure to a variety of segments of the financial markets.  

High-Risk Investors: Since small-cap funds come from small early-stage businesses, they are prone to be more risky than large-cap funds that are already established and have strong fundamentals to deal with market volatility. Thus, small-cap funds may be aligned with investors who have a high-risk profile.  

Investors Looking for Company Growth: Since small-cap mutual funds invest in the company stock of just-starting businesses, they are attractive to investors who wish to invest in growth opportunities that these companies may come with. Small firms have the potential to grow and develop into successful companies, and investors who value this don’t mind taking risks with the expectation of possible lucrative outcomes.  

Benefits of Investing in Small-Cap Funds 

Today, the best small-cap funds come with a host of advantages for investors. Here are some key perks offered by small-cap mutual funds:  

High-Growth Opportunities: The idea of investing in small-cap funds is to tap into the potential for growth of small-cap firms. Small companies have the ability to grow into large operations with time, and hence, small-cap mutual funds investing in their stock, have the potential for significant capital appreciation.  

Institutional Investors Don’t Invest: Institutional investors do not tend to invest in small-cap funds as they may be too insignificant to be noticeable. However, clever fund managers look for these hidden treasures as they may be undervalued presently but have the potential to become valuable with time. Hence, opportunities are created for organic growth by investing in such funds.  

How to Invest in Small-Cap Equity Funds

The way to invest in small-cap mutual funds is as simple and convenient as investing in any mutual fund these days. You can follow the steps below:  

Step 1: Locate an online asset management company, brokerage, or mutual fund house. Alternatively, you may physically apply for a mutual fund through your bank’s personal finance department, or physically at an asset management company or brokerage. You may even employ a financial advisor to assist you in your endeavour.  

Step 2: For the online route, you will see a tab to enter your details and apply for a mutual fund. You will have to undergo the eKYC process first, uploading your PAN and Aadhaar details as requested.  

Step 3: You can go ahead and invest in your chosen fund but see that you have researched many different funds before you make a decision. Before investing, you will be required to create a password and a User ID for your mutual fund account.  

Step 4: Once you make an investment aligned with your goals and personal investment profile, you will receive a formal intimation.  

Conclusion 

Among mutual fund categories, small-cap mutual funds give investors a way to explore stock investing with potentially positive returns but some degree of risk due to market volatility. Nonetheless, small-cap mutual funds have the real possibility of future growth and can diversify your portfolio and let you see capital appreciation in the long run. Additionally, small caps provide you with opportunities to find hidden treasures and let you make the most of market inefficiencies while