Why should you not get carried away with high returns by small cap funds?

Vimal Joshi
Updated: 13 Dec 2021, 12:04 PM IST
TL;DR.

It is easy to get tempted by high returns posted by small cap funds in the past one year, but experts opine that these funds are more prone to volatility when compared to their larger peers. We decode the distinction between small and large caps, and explore how it influences the investment decisions of small investors.

We tend to take our investment decision on basis of the past returns of funds

We tend to take our investment decision on basis of the past returns of funds

When we invest in mutual funds, our goal invariably is to maximise our earnings. More often than not, we tend to base our investment decision on the past returns of funds. And as it has turned out, the returns posted by small and mid-caps funds in the past one year are higher than their larger peers.

So, does that mean it is advisable to make a higher allocation to small cap funds? Well, the answer is not as straightforward as one would expect.

Past returns

In the past one-year, small cap mutual funds posted a high return in the range of 78 - 99 percent with a maximum of 98.57 per cent posted by Canara Robeco Small Cap Fund, as per AMFI India data.

Mid cap mutual funds also posted decent returns, i.e. in the range of 54 to 79 percent with highest return of 78.72 percent posted by Aditya Birla Sun Life Mid Cap Fund, the AMFI India data reveals.

At the same time, most large cap funds posted relatively lower returns — in the range of 47 to 61 percent with the highest return of 61.32 percent posted by Aditya Birla Sun Life FrontLine Equity Fund.

Need for caution

Experts say that investors should not be guided only by past returns alone as historical returns are not a surefire way to assess future returns. “Just because a fund posted impressive returns in the past doesn’t necessarily mean it will post high returns in future as well,” says Deepak Kumar Aggarwal, a Delhi-based financial advisor and chartered accountant.

 

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Investors should be mindful of the fact that small cap funds are illiquid

Some money managers argue that small caps funds are illiquid and even small inflows or outflows can lead to substantial movements in the prices.

Another reason for being cautious is the fact that volatility in markets causes disproportionately higher impact on small and mid-cap funds. This effect is more profound during the rising interest rate cycle.

Experts have already warned that the RBI is likely to raise interest rates in the first half of 2022 and will likely roll back its accommodative stance.

“Investors with low risk appetite should stick to large cap funds. In 2018, for instance, during volatility when large cap funds fell in the range of 2 to 3 percent on an average, the small cap funds witnessed a massive decline in the range of 7-25 percent,” says add Aggarwal.

As we summarise, we can highlight that there is no denying the fact that small funds posted better returns than their larger peers in the year gone by, but it does not necessarily mean that the high returns would continue in future.

The unit holders can even book profits and rebalance their portfolio in favour of large cap funds, which are relatively safer and less volatile to market fluctuations.

First Published: 13 Dec 2021, 12:04 PM IST
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