scorecardresearchInvesting in small cap funds: Are they good and bad both at the same time?

Investing in small cap funds: Are they good and bad both at the same time?

Updated: 26 Nov 2022, 01:46 PM IST
TL;DR.
Small cap mutual funds received the largest inflow of 1,581 crore against 1,385.33 in mid cap and 173.62 in large cap during the month of October. This can be seen as an aftermath of high returns posted by these funds in the recent past
Wealth managers say that investing in small cap funds can be good but the allocation should not form your core portfolio.

Wealth managers say that investing in small cap funds can be good but the allocation should not form your core portfolio.

Investing in small cap funds has turned out to be lucrative for investors in the recent past. As a category, these funds delivered a return of 30.60 percent against 22.73 percent by mid-caps and 15.23 percent by large-caps, MorningStar data revealed on November 21.

No wonder then these funds have lately become quite popular among investors who are always in the lookout of high returns. They received maximum inflow in October when compared with their mid-cap and large-cap counterparts.

Small cap mutual funds received maximum contribution of 1,581 crore against 1,385.33 in mid cap, 889.26 crore in multi cap funds and 173.62 in large cap mutual funds in the month of October, shows the AMFI data.

In the month of September as well, small cap funds received higher inflow of funds (at 1,825.48 crore) than their larger peers (at 274.18), albeit slightly lower than mid-caps ( 2,151).

MonthNet inflow ( crore)Net AUM ( crore)
Aug1,259.981,20,464.00
Sept     1,825.481,23,153.93
October1,581.911,26,095.84

(Source: AMFI)

High returns

Wealth advisors suggest that investing in small cap funds can be extremely rewarding because of immense potential they embody. “The whole thing about equity investment is spotting a bunch of small companies with a hope that they will turn big, and when they turn big, they turn out to be multi baggers. That’s the charm of small cap investing,” said Dhirendra Kumar, Founder and Chief Executive of Value Research.

Since it takes time for small cap companies to grow big and deliver high returns, so it makes sense to stay invested in these funds for a reasonably longer period.

“Investment in small cap funds should be made with a long-term horizon of minimum 5 years as this will help to play out market cyclicals,” said Nitin Rao, Head Products & Proposition, Epsilon Money Mart.

Exercise caution

Thanks to extreme volatility, displayed by small cap funds, investors should not only be cautious about investing in these funds but also ensure that they don’t comprise their core portfolio.

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Wealth advisors say that investors should be extra careful while investing in small cap funds since they are high beta funds

“While you take the risk of small companies becoming big & giving you good returns, the journey is not linear. It shouldn't form the core of your portfolio. Some allocation ranging from 10-20 percent for alpha generation should be ideal,” added Rao.

Besides, investors should not get dismayed when these funds fall steeply. Wealth advisors say that investors should be extra careful since they are high beta funds.

“The most important thing to look for before investing in a small cap fund is volatility & downside risk. Small cap funds are high beta funds, which means they carry high risk. Funds that are consistent in nature and have weathered the market cycles should be considered in line with investors risk profile and time horizon,” added Rao.

“They are rewarding but volatile. It takes a couple of years to get used to it. In 2007, the year before financial crisis, small cap stocks rose by 66 percent, next year they fell by 57 percent. And the year after that, they again doubled in value. If you invest at peak, your 100 can later become 25 also. So, it’s difficult to stay around and reconcile with the free fall whenever it happens,” says Dhirendra Kumar.

So, one can believe that small cap funds can add that extra dose of high returns to your portfolio, but while chasing ‘extra’ returns, one should not forget the first rule of investing – ‘Higher the return, greater the risk’.

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First Published: 26 Nov 2022, 01:46 PM IST