Best Small Cap Mutual Funds

Small cap mutual funds are schemes that have invested a major portion of the funds into buying stocks of small cap companies. By definition, small cap companies are ranked below 250 in terms of market capitalization, which amounts to less than INR 500 crores. SEBI mandates that in small cap mutual funds at least 65% of the portfolio must consist of small cap stocks.

The companies that come under the small cap category are much smaller than the ones in the large and mid cap category. The companies in large and mid cap are also much more established and reputed. This makes the stocks of small cap companies much more volatile and they generally tend to perform poorly in a bearish market.

Things to Consider Before Investing in Small Cap Mutual Funds

Investing in small cap mutual funds are considered risky. Most small cap companies tend to go through lots of ups and downs as they do not have the capabilities and resources like the bigger companies. The small companies are much more susceptible.This coupled with the fact that there are unethical and devious elements among the market drivers who associate with some companies to make tall claims and drive up the prices that is not sustainable for any significant period. The small cap funds may offer very high returns in a shorter period of time that attract a lot of investors who want some easy money.

But it’s not all bad news and bleak outlook. There are a lot of honest management and bona fide enterprises. Good small cap mutual funds are about identifying such listed companies and investing in their stocks.

Associated Risks: There is a real risks associated with small cap funds. Small cap funds are invested in companies that are predicted to have a great future. But that may not always be the case and if they don’t perform well then the prices of their shares can go down drastically. The effects of a bear market are also more pronounced in the small cap market and there is a tendency to dump mid and small cap investments when things go bad. Some small cap companies may even not survive a negative market. All these factors contribute to significant risk. So small cap funds are a great opportunity for investors who are looking for aggressive growth and afford to take risks.

Funding Houses and Fund Size: Small cap funds are about identifying promising listed small cap companies, buying their stocks, and then waiting patiently. This is an extremely challenging and difficult task. Also smaller fund sizes are ideal for small cap funds as there are less investment options. Select fund houses with a history of well managed small cap funds for investing.

Investment Horizon: Small cap companies tend to be very susceptible to market fluctuations. A bull market generally starts in large cap before it spreads to small cap. But the effects of a bear markets are felt first in small cap schemes. This means that small cap suffer heavily in bear market and recover slowly in a bull market. So small cap schemes perform best in the longer run giving them sufficient time redeem losses and generate returns. Investment horizon of seven to ten years is ideal for small cap funds.               

Expense Ratio: The annual fee charged by the funding houseto cover the costs incurred in managing the scheme is known as expense ratio. SEBI has set the upper limit of expense ratio is set at 2.25%. So a fund with a lower expense ratio will give better returns.

Taxation: Small cap fund returns are subject to capital gains tax and the rate of taxation is dependent on the investment period, also known as holding period. For an investment period of up to one year the taxation rate is 15% as the profits made from the investment are considered as short-term capital gains. If the period is more than one year, then the capital gains is considered as long term capital gain and amount of upto INR 1 lakh is not taxed. The rate of taxation is 10% for gains above INR 1 lakhs.

Best Small Cap Mutual Funds in India

Below is the list of the best small cap funds:

  1. Axis Small Cap Fund
  2. Kotak Small Cap Fund
  3. Edelweiss Small Cap Fund
  4. SBI Small Cap Fund

Advantages of Small Cap Funds

The following are the advantages of small cap mutual funds

Higher Growth: Small cap schemes have a greater growth potential compared to mid and large cap. These companies are relatively new and small, and hence they have a greater scope for growth and expansion. There is also possibility of these companies being acquired by bigger ones or the small cap companies acquiring other companies and exhibit inorganic growth. Small cap stocks gains are also higher during bull runs. Thus the small cap schemes can achieve exceptional growth.

Undervalued Assets: Most of the small cap companies remain undervalued and are not researched thoroughly. The shares of these companies are generally undervalued and available at lower prices. So the small cap schemes are a very good option for investors are willing to take risks.

Lower liquidity: Small cap shares will have low liquidity, which may be seen as a disadvantage by institutional buyers. This can work in favor of retail investors who can benefit from the high growth potential of the shares.

Diversification of Portfolio: The large and mid cap funds may show mediocre performance while the small cap funds may have exceptional growth. Diversifying your investment portfolio by investing in small cap funds will help balance the portfolio.

Points of Note

  • Investing in small cap mutual funds comes with its own set of advantages and disadvantages. You must understand that small cap funds are very volatile and risky compared to mid and large cap funds. If you are a novice to mutual fund investments you have to understand all the risks and difficulties that come with investing in small cap funds. It is best suited for seasoned investors.
  • At Nuuu we help you make the right decision. There are a lot of small cap mutual funds from reputed funding houses with varying portfolios to choose from. Our fund managers? will sit with you, understand your requirements, and recommend specific schemes, and help you select a small cap fund that is right for you. We will continuously monitor the performance of these funds and advise you on the course to take.
  • Do not invest in small cap schemes when you see huge returns and do not panic when there is a downturn.
  • The investment decision is yours to make. We honour your decision.