Small cap funds have been a preferred choice of investors that are looking for long term wealth creation at an accelerated rate. Since small cap funds invest in stocks of companies that have high growth prospects, they have rewarded steadfast investors with good returns in the past, and continue to do so. Let’s see in detail what are small cap funds and the best performing small cap funds that investors can consider.
What are small cap funds?
Mutual funds that invest primarily in the companies holding a rank below 250 in terms of market capitalization are known as small-cap funds. These funds need to allocate at least 65% of their total assets in small-cap equity, whereas the balance 35% of funds can be invested in any of the large, mid, or small cap equities.
Why are small-cap funds popular among investors?
Despite a higher amount of risk in comparison to the large and mid-cap funds, small-cap funds are highly popular among retail investors.
- Small-cap is a space where the possibility to beat the average market return (also known as Alpha). As the small-cap companies are young and carry the potential to grow exponentially, there are high chances for your money to grow aggressively if your fund has invested in the right set of stocks.
- Since there are more than 2000 small-cap stocks available against only 100 large-cap and 150 mid-cap, the fund managers have more options to choose from to diversify the fund.
- Most of the equity analysts focus is limited to large and mid-cap stocks, small-cap stocks provide the fund managers with the opportunity to tap into the lesser-known yet potential stocks.
Benefits of small-cap funds
- Higher potential for growth: Small-cap funds offer a higher rate of return. By doing a thorough analysis of the best small cap funds available and diversifying your investment in multiple funds, investors can expect a higher rate of return in the long run.
- More focused: The small-cap companies tend to stay more focused than the large-cap funds. As these companies are not expanded into various business lines, they tend to grow more and offer better returns.
- Flexibility: Small companies have more flexibility than large companies. Hence, they adapt to the changes easily and quickly and help investors gain more returns.
Things to consider before investing in small-cap funds
While the top small cap mutual funds offer a benefit of higher returns over the long run, unlike other equity investment tools, they are not devoid of risks. As an investor, it is important to keep various factors in mind before building your portfolio.
- Risk factor: Since the small-cap companies are young and not as stable as large and mid-cap funds, there lies a higher amount of risk. At the time of downfall in the market, these types of funds tend to suffer more since the companies are less established and may even shut down their business in adverse situations.
- Performance history: Past performances are a signal of fund managers’ efficiency. If a fund has performed well in the past, chances are high that it will continue to generate returns.
- Diversification: When the risk factor is high, diversification can be the best strategy. Even the best small cap mutual funds can suffer in a downturn. Hence, it is important to invest in multiple funds.
- Expense ratio: To manage your investment in the market, fund managers charge a handsome annual fee, also known as the expense ratio. There is a limit set by SEBI which is 2.50% of the average asset under management. The higher this charge, the lower would be your return. Therefore, while choosing a fund, try to look for the ones that provide a lower expense ratio.
- Investment timeline: In order to generate a substantial return from small-cap funds, it is important to stay invested for a longer time. While these funds suffer the most in a market downturn, they gain the most when the market corrects. Hence, invest in these funds only if you have a long-term financial strategy.
- Financial Goals: Small-cap funds are not for investors who are investing to meet short term goals. The investors who are setting long term goals like saving for your retirement, children’s education, child’s marriage etc should only opt for small-cap funds.
List of the Best Small-Cap Mutual Fund Scheme of 2020
It is very important to make the right choices while investing in small-cap mutual funds. For your convenience, our experts have handpicked the best small cap funds to invest. Here is a list of top 5 small cap funds with the return they have generated over a period of time.
| Name of the scheme | 1 Year Return | 3 Year Return | 5 Year Return |
| Axis Small Cap Fund | 22.76% | 15.63% | 12.77% |
| SBI Small Cap Fund | -7.19% | 10.96% | 10.47% |
| ABSL Small Cap Fund | -3.66% | -27.01% | 8.63% |
| DSP Small Cap Fund | 9.02% | 18.99% | 33.66% |
| HDFC Small Cap Fund | -5.37% | -14.53% | 34.28% |
| ICICI Prudential Smallcap Fund | -10.87% | 23.83% | 35.09% |
| Kotak Small Cap Fund | 12.46% | -7.51% | 27.25% |
| Nippon India Small Cap Fund | -0.04% | 10.25% | 11.33% |
As you can see, small cap funds are volatile when it comes to short-term returns. For example, the top small-cap fund, Axis Small Cap Fund has generated an exceptionally good return in the short term, but SBI Small Cap Fund has generated a loss. At the same time, Nippon India Small Cap Fund remained neutral. However, in the long run, all the small cap funds have generated a positive return.
Investing in small-cap funds might be a roller coaster ride for the investors, but if you have a better risk appetite with long term vision, you should definitely include them in your portfolio.
