Small Cap Mutual Funds – Concept, Return & Risk Prospects, Compatibility, Features & moreLast Updated Date: May 11, 2022
Know everything about Small Cap Mutual Funds here.
When we talk about equity mutual funds, then one thing which goes without saying is market capitalization plays a crucial role.
Simply you can say that value of the company which is traded on the stock exchange is market capitalization.
It is pretty easy to calculate as all you need to take into account is multiply the latest value of shares with the number of outstanding shares.
Additionally, you can’t ignore the market capitalization mainly because it helps in determining the returns available on shares.
Plus, you can also get an estimate of the risk factor. Well, in this guide, we are going to focus mainly on small cap funds.
These funds choose to invest the capital amount that ranks below 250 in the stock exchange with regards to market capitalization.
Thanks to the higher returns, the small-cap funds have taken the investors by a storm.
In simple terms, the smallcap mutual funds invest in companies having market capitalization value below Rs.500 crore.
About Small Cap Mutual Funds
Ideally, when you choose to invest in small cap funds, then you need to know that fund managers invest the majority of the amount in equity. And equity related instruments of Small cap companies.
As per the SEBI guidelines, the fund houses need to invest at least 80% of the amount of corpus into small cap companies.
Furthermore, SEBI also defines that companies that fall below the ranking of 250 in the stock exchange are small cap companies.
You also need to know that a small cap company tends to have a large amount of risk. Additionally, even a tiny amount of market volatility leaves a significant impact on the fund.
Besides this, the funds also tend to offer excellent returns. For example, you can think of it as a small company that has a great potential to grow, so eventually, the prices of the stock will shoot.
When the prices of securities of small cap companies increase, the value of the fund also rises. But the majority of the investors choose to invest in small cap companies only for a short period.
It doesn’t work well in practical terms as small companies take a lot of time to grow.
Hence, you must choose to invest in small cap funds only if you have a high risk taking appetite and a long term investment horizon.
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Risk and Return Prospects of Small Cap Mutual Funds
One of the most essential variables that decide whether you must invest in a fund is market capitalization.
As compared to other equity funds, the small cap funds are quite risky, but they promise stable returns in the long term.
Experts advise investors to keep some amount of smallcap mutual funds in their portfolio so they can earn higher returns.
You must be wondering what does the term cap means in capitalization. Generally, small cap companies are those which have a market capitalization below Rs.500 crores.
In simple terms, these companies are young budding companies that look forward to thriving and expand.
When the market slumps down, the shares of small cap companies tend to be vulnerable as the volatility hits them.
Under a small cap company, the fund manager tends to have an exposure of 60-65% to the small cap funds. Over institutional investors, the small cap mutual funds give individual investors some edge.
It is mainly because institutional investors tend to choose large cap funds due to stability. On the other hand, investors who expect more returns invest in small-cap funds.
Hence we can say that the composition of funds plays an essential role. And you might be endangering your returns if you make a decision in haste.
Experts advise you to invest in multiple funds so you can get some diversification in your portfolio.
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Who should Invest in Small Cap Funds?
If you are willing to invest in small cap mutual funds, then you must have a tremendous risking taking appetite.
Above all, when you are creating your portfolio, then you must have a benchmark. It is essential because you can easily compare your returns.
The best part about comparing the past performance of the funds is that it allows you to gauge the ideal performance of the fund.
One of the best strategies to mitigate the risk is through a systematic investment plan. Well, if you choose to ignore the small cap fund for investing in the first place, then you might even miss out on return.
Above all, you need to have some patience when it comes to dealing with small cap funds. Or else, you might end up losing those gains.
When the market is bearish, then these funds offer great returns. But the funds are positively affected when the markets dip.
Features of Small Cap Mutual Funds
Here a various things that you must consider before investing in Small Cap Mutual Funds –
The small cap mutual funds ideally face market risk. In simple terms, the net asset value of the fund changes when the underlying benchmark moves.
The small cap funds tend to suffer much when the market doesn’t perform up to the mark. It is mainly because the small cap companies are still growing, and they choose to move out of the business.
On the flip side, small cap funds are excellent investment tools for investors who have a tremendous risk-taking appetite and investors who are also looking for greater returns.
In the last few years, the experts say that market has performed exceptionally well in the small cap companies. It is the only reason why small cap funds are so prominent among investors.
No doubt, the small-cap funds are quite necessary, but their returns aren’t visible to everyone. They offer a significant amount of return, so you can surely add them to your portfolio.
Even if you are going through some risk, then these funds will act as a buffer in the portfolio. If things work well in the market, these funds offer great returns.
Just like all other funds, the fund managers charge some fees to manage the small cap funds. As per SEBI guidelines, the upper limit for the expense ratio is 2.5%.
At the end of the day, you can say that the lower the expense ratio, the higher is the amount of return. Hence when it comes to choosing a fund, you must look for funds that offer a low expense ratio.
When the market starts falling, the small cap mutual funds tend to face a downfall. Hence you need to invest for the long term in the smallcap funds, as it allows you to generate greater returns.
In terms of long term investment horizon, we mean you must invest for at least seven to ten years.
The small cap mutual funds are perfect investment avenues for people who have long term financial goals. It can include anything from planning your children’s marriage to your retirement.
As per the historical records, these funds offer returns above the benchmarks. But they are risky too. The small cap funds invest money in companies that hold the potential to generate significant returns.
Taxation on gains
You earn some capital gains on redemption of units of mutual funds. In your hands, these returns become taxable. Depending on the holding period, you need to pay the returns.
On short-term capital gains, you need to pay a return of 15%. On the other hand, on long term capital gains, you need to pay a return of 10%.
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Small Cap Mutual Funds – Conclusion
Hence, before investing in small-cap funds, you must consider all the factors which impact the performance of the funds. It is essential because small cap funds are liable to risk.
Above all, after investing in this fund, you must be patient as the fund offers some fantastic opportunities to earn significant returns.
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