Small-cap stocks usually are quite volatile. Since their market cap is low, the inflows and outflows can result in huge price variation.
Under this category, there could be some companies which are struggling to survive and also the ones which are small but healthy. Wealth advisors often advice investors to diversify in mutual funds across market capitalisation and to refrain from going big on any one category.
Some investors, however, get too carried away with the high returns, not realising that the results are the direct result of fluctuation and may not be the true reflection of their performance.
“I have had clients who come and tell me that a particular small cap fund gave 40 percent return, even if it gives 20 percent next year, it would be fine. They don’t realise that the high returns for small caps are not sustainable,” said Amol Joshi, Founder of Plan Rupee Investment Services.
Here we compare the small cap funds with their counterparts in large-cap and index funds in the past five years:
Small cap funds: The returns of small cap funds in past five years range between 5.86 percent to 18.97 percent. Although the five-year returns are healthy and better than those of index funds and large cap funds, but it is seen as a result of volatility.
The small cap funds that gave high returns delivered even better returns in past three years i.e., in the range of 24-29 percent. At the same time, the past one year returns of these funds were in single digits i.e., 6-9 percent. This is what they refer to as ‘volatility’.
Returns of top-performing small cap fund schemes:
| Small cap funds | 1-year (%) | 3-year (%) | 5-year (%) |
| Axis Small Cap Fund | 8.99 | 25.93 | 18.91 |
| Kotak Small Cap Fund | 6.63 | 29.11 | 16.90 |
| SBI Small Cap Fund | 6.31 | 24.73 | 18.28 |
| Nippon India Small Cap | 9.57 | 26.40 | 17.22 |
(Source: AMFI, as on June 30, 2022)
Index funds: The past five-year returns of index funds were around 12 percent only. HDFC Nifty 50 ETF gave 11.90 percent return and SBI Nifty index fund gave 11.48 percent return.
The past three-year returns were slightly lower but the difference was not very wide. However, past one-year returns were flat since the broader market indices have been falling for some time, particularly since October last year.
Returns of top-performing index fund schemes
| Fund schemes | 1-year(%) | 3-year (%) | 5-year (%) |
| Franklin India NSE Nifty 50 Index | 1.31 | 10.85 | 11.17 |
| HDFC Nifty 50 ETF | 1.61 | 11.37 | 11.90 |
| SBI Nifty Index Fund | 1.38 | 10.93 | 11.48 |
(Source: AMFI, as on June 30, 2022)
Large cap funds: The returns given by large cap funds range between 5.69 to 13.89 percent for most of the fund schemes. The performance of top performing large cap funds ranges between 10-13 percent. The three-year returns were slightly lower i.e., between 10-12 percent. The one-year returns were quite low for large cap funds. Some of the funds were even in negative.
Returns of top-performing large cap fund schemes:
| Large cap fund | 1-year (%) | 3-year (%) | 5-year (%) |
| Axis Bluechip Fund | -5.76 | 10.48 | 13.31 |
| Edelweiss Large Cap Fund | -1.47 | 11.94 | 11.87 |
| Mirae Asset Large Cap Fund | 0.67 | 12.01 | 12.03 |
(Source: AMFI, as on June 30, 2022)
As we can discern, small cap mutual funds have shown higher returns in past five years as well as in shorter durations. But given the volatility demonstrated by these funds, investing in them is riddled with risk. The higher the volatility, the higher is the risk of capital.
While explaining the dynamics of volatility in the context of probability of loss of investment, Ankur Kapur, Founder of Plutus Capital says, "If your portfolio has grown from ₹1 lakh to ₹10 lakhs, as per finance literature, the portfolio is quite volatile, but this is a positive side of the volatility. Therefore, when an investor evaluates equity investment, risk should be seen as a probability of loss of capital and not volatility."
