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Best Small-cap Mutual Funds to Invest

Investment rewards and risk go together, especially in equity-oriented funds. This relationship becomes more prominent when the expectation of reward is higher. Every investor has a different appetite for risk and — in co-relation — expectation of return. To align these two factors, fund houses curate equity mutual fund portfolios. If you are on the hunt for investing in the ideal mutual fund, you will come across plenty of choices. Some funds have low risks and steady returns, some have moderate risks with high returns and some are extremely risky but also give the highest returns.

Large-cap portfolios comprise of the top 100 stocks and are the least risky, whereas, mid and Small-cap portfolios cover the remaining listed stocks and have a moderate to high risk:reward ratio. A ‘cap’ is short for ‘market capitalisation’ or ‘market-cap’, which gives you the asset size of a company.

Small-cap funds are those that have 60%-90% of stocks (in a portfolio) invested in Small-cap companies. These companies rank from 250 upwards in Indian stock exchanges, with an asset size of less than ₹5000 crore. Small-cap companies are primarily starting up or developing and have relatively lower revenues and fewer employees.

The stocks in these funds tend to be hypersensitive to market corrections. A minor shift can throw stock prices in an uncontrollable spiral. Historically, these funds have recorded returns of over 20% which are the highest among all cap sizes.

The best Small-cap mutual funds will have quality stocks and a blend of stable, low-risk ones as well. This helps you as an investor to not only get the highest returns but also reduce risks associated with market volatility. We also recommend you hold these investments for a longer period rather than exiting from it as soon as the lock-in period (three years) ends. This is because companies in nascent stages of growth are constantly growing and expanding; it takes a minimum of five years for any visible results to affect stock prices for these companies. Also, the longer you hold your investments in these funds, the higher the return and it gives stock prices time to correct from volatility.

Small-cap Mutual Funds

Small-cap mutual funds have 60%-80% corpus allocated to Small-cap stocks. A typical portfolio will have NAV of these stocks fluctuate regularly. The stock prices themselves are highly volatile and to become erratic at the slightest shift in markets.

The best Small-cap funds will give you extremely high returns in bullish (positive) markets but will also plummet drastically when markets become bearish (negative). This loss on returns is balanced by the large or mid-cap stocks in the portfolio.

You need to have a huge appetite for risk and we recommend these funds mainly for expert investors. If you’re new to the market, you may panic by looking at your portfolio’s volatility. We also recommend you hold your investment in these funds for longer. The ideal time-frame to get the best of your returns on investment is 5-7 years. The reason is, the longer you hold your portfolio, the better is the performance of volatile stocks and the easier to recover losses from market corrections. Here’s a list of Small-cap funds you can choose from:

Top Small-cap Mutual Funds to Buy

Market experts are of the opinion, it is better to systematically invest in Small-cap funds rather than putting all your money in at once. This not only gives you proportionately higher returns, but also, spreads your risk over installments. We do not guarantee risk-free returns, but by investing in installments, the brunt of the risk will be easier to bear.

The top Small-cap mutual funds have been curated based on past performance and historical returns. These funds have outperformed the benchmark and have been known to give returns as high as 20%. Also, these funds tend to exceed expectations only after longer periods. If your investment horizon is at least seven years you can get the best returns from your investment in these funds. Here’s a list of our recommendations:

Factors to Consider Before Investing in Small-cap Mutual Funds

Here are important things to consider before investing in Small-cap funds:

  • Understand Associated Risks: These funds have extreme responses to even minor shifts in the market, which means, the NAV of the stocks fluctuates drastically. These fluctuations also lead to a shift in the underlying benchmark. In a bullish market the stocks in these fund portfolios outperform the benchmark, but in a bearish market, the stock prices tend to plummet, affecting the NAV. Understanding the levels of risk is crucial before investing in these funds. The best Small-cap funds will have quality stocks with a good track record and the ability to recover losses.

  • Past Performance and Returns: According to market reviews, the performance of Small-cap funds have been exceptional. It is believed, these funds can recover from market slumps and give the highest returns. This also means some quality Small-cap stocks may move up the list to become mid-cap ones. Some Small-cap stocks have recorded a jump of 5x their original stock price. Moreover, the best of these funds have given returns as high as 20%.

  • Investment Holding Period: All mutual funds have a lock-in period of 3 years after which you can either hold your investment or sell it. For these funds, we recommend you hold them for at least seven years to get maximum returns. The stocks in a Small-cap portfolio are highly volatile which means you need a longer time-frame to understand what market factors affect them. A longer holding period also helps stock prices recover from poor market conditions and give you the highest returns on investment.

  • Financial Goals: Before investing in any mutual fund, you need to define a clear and realistic investment milestone. These funds are ideal for long-term investment goals like exotic vacations, saving for education or retirement or even paying off debts.

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