Small Cap Fund – Review

What is Small Cap Fund?

Small cap funds primarily invest in the small cap business. These funds have mandated to invest a minimum of 65% of their investment in small cap companies, most of which are young and have aggressive growth prospects, so they typically have high growth potential.

Small-cap companies have higher risk of investor capital loss than their mid- and large-cap counterparts, making them more volatile than those companies. These funds have the potential to generate sharply negative returns during periods of market instability.

Investing in businesses that may grow to be large-caps in the future is the philosophy.

Characteristics of small cap mutual funds:

• Funds that invest in small-cap companies. These are newly formed start-ups or small businesses with modest revenues.
• The businesses that small-cap mutual funds invest in are prepared for significant future growth.
• Small-cap funds have a high degree of volatility. This occurs as a result of the financial instability of small-cap firms. They are also not as well-known as bigger businesses.
• Small-cap funds involve high risk. For investors with high risk-taking capacities and an appetite for aggressive expansion, they can produce excellent profits.
• During a bull market, small-cap funds beat mid- and large-cap mutual funds. A bull market occurs when share prices increase, which promote purchasing.
• During a bear market, small-cap funds’ performance declines significantly more than that of mid- and large-cap funds. When share prices decline and selling becomes more prevalent, it is called a bear market.

Stocks are categorized on the basis of market capitalization and in the interest of uniformity, SEBI has defined large, mid and small cap companies as follows:

• Large cap: 1^st to 100^th company in terms of full market capitalization
• Mid cap: 101^st to 250^th company in terms of full market capitalization
• Small cap: 251^st company onwards in terms of full market capitalization

The key features of small cap companies are:

• The majority of listed companies fall under the category of small caps, which are significantly smaller than large and mid cap firms.
• The growth of these businesses is still in its early phases, therefore not all will be successful. This implies that small cap companies, if chosen wisely, have the ability to develop and offer better returns than large and mid company stocks, particularly during bull markets.
• However, it also implies that they may suffer losses in tough economic times. These businesses may find it difficult to get back on track because of their tiny size and restricted access to resources.
• Small-cap stocks typically have a high promoter ownership proportion and, as a result, a low share float or volume of shares traded in the market. During challenging markets, the share price’s already high volatility is made worse. Possibility is that not enough people will want to buy the stocks at the current stock price.
• In addition, compared to their large and mid cap counterparts, small cap companies are not as well researched. The reward, if a good company is found early on, can be enormous, but the negative, if enough is not known about the company and management or governance issues arise, can be brutal. 

Advantage & Disadvantage of Small Cap Fund

Advantage

1. The main advantage of investing in small-cap funds is the significant upside growth potential that is unmatched by the bluechip companies with large market capitalisation under large cap funds.
2. Exposure to small-cap funds can help boost portfolio returns as these funds tend to reward those who stay invested for a long term.
3. There is a possibility of these stocks being undervalued since these small-cap companies are relatively new and unknown and could be available at a discounted rate.
4. They tend to outperform the large-cap and mid-cap funds in a bull run, giving you a huge opportunity to grow your investments quickly and earn superior returns.

Disadvantage

Small-cap companies’ high levels of uncertainty lead to sharp market ups and downs in the short term, making the portfolio unpredictable and unstable.

Small-cap funds offer greater potential for growth, but they also carry greater risk. As a result, only experienced investors or those with a higher risk tolerance should consider them.

Since growth stocks in general are small cap companies, they often keep all profits in order to reinvest them back into the business. This results in minimal or no dividends.

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Due to the limited liquidity of these stocks, the low volumes at the time of buy and sale may have an impact on or change the share price, which may have an impact on the portfolio’s performance.

How much returns can you expect from a small cap fund?

Small cap funds have a much better long-term capacity for wealth creation than large and mid cap funds as they are mainly invested in small cap stocks.

To achieve high returns in the long run, small cap funds take a very high risk approach. Even the best small cap funds can suffer losses, lose money quickly, or perform worse than their benchmark indices during a downturn.

How do small cap funds be analyzed?

Choosing the right small cap fund is really difficult when there are so many options available.

The following are the most important criteria if you’re looking for the best small cap fund.

1. A track record of consistency and outperform peers, the benchmark index, and the category average
2. A risk-adjusted return- Calculation of investment profit that factors for the level of risk that must be accepted in order to achieve it.
3. Capacity to limit downside risk
4. AUM size- High AUM in the small cap fund category, which makes it difficult to recognize chances to deploy money and to buy or sell at the correct price even when they had been forecast.
5. FUND MANAGER & Fund philosophy

Conclusion

I have tracked this category for the past ten years. I really enjoy this category. However, you are aware to adjust your portfolio according to market conditions.

Blockbuster returns are possible with small cap funds. Small-cap equity funds, are the riskiest sort of funds you can add in your portfolio.