Small Cap Funds

What Are Small Cap Funds?

Small cap equity mutual funds invest in companies that rank below 250 in terms of market capitalisation. Since 2018, all stocks are indexed descending on market capitalisation. Small-cap funds have to invest at least 65% of their corpus in small cap stocks. They invest in small revenue companies that have a market capitalisation of less than 5000 crore rupees. The funds are volatile in nature, but the small revenue companies they invest in have high growth prospects in the long term. You have to bear in mind that these companies are generally not diversified and they focus on a single line of business.

Who Should Invest in Small Cap Funds?

  • Small caps can even double or triple in value over the long run in a bull market, so they are a great addition to your portfolio in spite of posing a significant amount of risk. Hence, these funds are perfect for investors who have an appetite for risk. These funds tend to outperform large cap funds in the long run provided you buy them early in a bull market. However, in a bear market, the mid and large cap funds outperform the small caps
  • It is best to invest in small caps for a period of 5-7 years because in a bear market small caps perform poorly. These funds are ideal for investors who have a long investment horizon. You should have some long term goals in mind while investing in small caps. You can plan for your retirement, your children's education or buying a retirement home when investing in these funds for the long term
  • These funds work well for investors who want a diversified portfolio by holding small cap, mid cap and large cap funds. In a bull market these funds outperform large caps, while in a bear market investment in large caps can help improve the performance of the portfolio since small caps underperform in a bear market
  • If you are a patient investor, a small cap fund is perfect for you. Never panic and sell or buy in a hurry. You need to be patient to book profits when you buy a small cap fund. Don't try to time the market

Features of Small Cap Funds

  • Small caps invest in young companies that are not very diversified. These companies generally have a single line of business and a market capitalisation less than 5000 rupees
  • Even though small caps are risky, they tend to outperform large cap funds in the long run and are perfect for aggressive investors. Small caps generally outperform large cap funds in a bull market, but in a bear market large caps tend to outperform small caps
  • Small caps invest a very small portion of their corpus in higher market capitalisation stocks since they have to invest at least 65% of their corpus in small cap stocks
  • Liquidity is a problem for small caps since it is difficult to find small cap stocks in in the required volume
  • Since there is a shortage of small cap stocks, many small caps often stop the fresh inflow of capital from investors

Taxability of Small Cap Funds

  • Capital gains refer to the amount of money that is earned in excess of the investment when you redeem a small cap equity fund. Capital gains depend on how long the money was invested in the small cap fund. The number of years for which you invested your money in small caps is called the holding period.
  • If the holding period is up to one year then the short term capital gains are taxed at 15%. In case the holding period is greater than 1 year, then the gains are called long term capital gains. The long term capital gains of over one lakh are taxed at 10%.

Risk Involved With Small Cap Funds

  • It is best to invest in small cap mutual funds through a systematic investment plan to reduce volatility since these funds are risky. A systematic investment plan is one wherein you invest a small amount of money periodically at predefined intervals in the small cap fund instead of a lump sum amount of money in one go. This is to ensure that you benefit in the long run regardless of the market dynamics. The compounding effect of your investments ensure that you earn not only on the principal amount but also on the gains on the principal
  • Small Caps perform poorly in a bear market so the consistency of the funds and the downside risk should be taken into account while forecasting the performance of the funds. The consistency of a fund is measured by the Hurst exponent. The downside risk is the estimation of the fund’s loss in value if market conditions cause a decline in the security prices
  • Small caps carry a higher expense ratio than large cap funds so your net small cap fund return post expenses may be lower than what you expect. Although an expense ratio with an upper limit of 1.5% is preferred, small caps typically have a an average expense ratio that is higher. This is because small cap mutual funds have to conduct primary research and have many analysts contribute to the research. The reason for this is that small cap stock research is not as easily accessible as large cap stock research. The best small cap funds are the ones with an expense ratio of less than 1.5%.

Advantages of Small Cap Funds

High Returns In a Bull Market

These funds invest in companies that have high-risk high-return potential. The small cap fund returns are generally high in a bull market, but it is important to look at the track record of the small caps before investing in them. The returns over a five year period should be studied to understand the performance of the best small caps.

Help to Diversify Your Portfolio

Small caps help to diversify your portfolio. Funds can be shortlisted after taking into account their mean rolling returns rolled daily for the last three years. Rolling returns are the annualised average returns for a period ending with the listed year. These returns can examine the behaviour of small caps for the holding period. The rolling returns give the performance of the fund smoothened over several periods throughout its history.

The small cap category has offered a return of 37.79% in the last year. Investors believe that the small cap category may repeat its performance in 2022. Remember small caps are a risky investment and you should not try to time the market. The best practice is to simply invest in small caps for the long term.

Who are the Small Cap Funds suited For?

Small cap funds are associated with higher market risks. Since the underlying stocks belong to smaller companies that operate at higher financial and organizational instabilities, these funds tend to take a hit in a bearish market. A bullish market favours small cap funds generously in that they have the potential to outperform mid and large-cap funds.

It all depends on selecting the best small cap funds while carefully considering certain aspects discussed below.

Investment Goals

Every individual has their own investment goals from a fund. One may be looking to invest in a fund for a single year; the other may be investing for 3 years. Small cap funds are best suited for long-term investors who are willing to stay invested for over 5 years.

Expense Ratio

When you invest in a mutual fund, such as the best small cap funds, you typically do so through an Asset Management Company (AMC). This company levies a cost on you to manage your funds that goes towards administrative expenses, legal expenses, custodial fees, fund manager’s commissions, etc. This is called the expense ratio of a small cap fund.

Past Performance of Small Cap Fund

The historical trends of a small cap fund’s performance are a good indicator of how it has fared during the ups and downs of the market. These dynamics help you understand whether or not a small cap fund will be a worthwhile investment.

Fund Manager Skills and Experience

In the end, your fund manager would make the decisions on buying and selling fund assets. Before putting your money in a small cap fund, it is best to scrutinize the fund manager’s portfolio to understand how good the person is with his market judgment.

Small Cap Fund Portfolio

Mutual funds comprise different assets belonging to various sectors and industries. Examining a fund’s portfolio helps you determine the actual worth and value of investing in it by carefully drawing observations of those assets in the market. If the performance matches your expectations, invest in the small cap fund.

Direct and Regular Plans

Investing in mutual funds through an AMC involves brokers and brokering agencies that have their own cuts and commissions, which raises the expense ratio of the small cap fund. Look for a direct plan with an AMC that does not involve any middlemen.

Best Small Cap Funds

The performance of your mutual fund portfolio depends on selecting the best small cap funds available on the market. Out of your numerous choices today, the following small cap funds have been known to perform well with a reliable track record of steady growth and good returns.

Quant Small Cap Fund – Direct-Growth

Quant Small Cap Fund (Direct-Growth) is a decent small cap fund with a total of ₹8,788 crores in Assets Under Management (AUM) as seen on 11th August 2022. The fund invests its assets in industries like Consumer Non-Durables (17.58%), Pharmaceuticals (6.82%), Industrial Capital Goods (41%), Banks (6.19%), and Non-Ferrous metals (6.03%). ITC, IRB Infrastructure Development, ICICI Bank, Hindustan Copper, and Linde India are among the top five holdings of this small cap fund.

This fund has an expense ratio of 0.64%, and it does not have any exit load. The minimum lump sum investment required for this fund is ₹5,000. Quant Small Cap Fund – Direct-Growth is a very high-risk fund with a one-year trailing return of 49.89% and a NAV of ₹34 which has remained over ₹110 for a year. The fund is 10 years old.

Bank of India Small Cap Fund – Direct-Growth

Bank of India Small Cap Fund – Direct-Growth is a decent small cap fund with a total of ₹2,948 crores in Assets Under Management (AUM) as seen on 11th August 2022. This fund invests its assets in industries like Industrial Products (16.56%), Auto Components (9.81%), Consumer Durables (9.43%), Debt (7.18%), and Banks (6.95%). TREPS, Timken India, ICICI Bank, City Union Bank, and KPR Mill Limited are among the top five Bank of India Small Cap Fund – Direct-Growth small cap fund holdings.

This fund operates at an expense ratio of 1.12%. The exit load for redemption/switches out is up to 10% of initial units. Within 1 year from the date of allotment, it is nil. If you switch out within 1 year, it is 1%. For redemption / Switch out after 1 year, it is nil. The minimum lump sum required for this fund is ₹5,000. It is a very high-risk fund with a trailing return of one year of 41.73%. It has a NAV of ₹27.65, which has been consistently over ₹22 for the past year. The fund is 4 years old.

Canara Robeco Small Cap Fund – Direct Growth

Canara Robeco Small Cap Fund – Direct-Growth is a decent small cap fund with a total of ₹49,253 crores in Assets Under Management (AUM) as seen on 11th August 2022. This fund invests its assets in industries like Debt (9.17 %), Consumer Durables (8.79 %), Industrial Products (8.27 %), Finance (6.72 %), and Auto Components (5.19%). TREPS, Schaeffler India, City Union Bank, Can Fin Homes, and Cera Sanitary are among the top five Canara Robeco Small Cap Fund – Direct-Growth small cap fund holdings.

This fund operates at an expense ratio of 0.41%. The exit load for redemption / Switch Out within 1 year of allotment is 1% and nil afterward. The minimum lump sum required for this fund is ₹5,000. It is a very high-risk fund with a trailing one year’s return of 41.63%. It has a NAV of ₹25.74, which has been consistently over ₹20 for the past year. The fund is 3 years old.

Kotak Small Cap Fund – Direct Growth

Kotak Small Cap Fund: Direct-Growth is a decent small cap fund with a total of ₹2,83,897 crores in Assets Under Management (AUM) as seen on 11th August 2022. This fund invests its assets in industries like Consumer Durables (26.6%), Industrial Products (12.59 %), Debt (7.61%), Auto Components (6.16%), and Retailing (3.49%). TREPS, Century Plyboard, Carborundum Uni, Sheela Foam, and Galaxy Surfact. are among the top five holdings of the Kotak Small Cap Fund – Direct-Growth small cap fund. This fund operates at an expense ratio of 0.59%.

When redeemed/switched out of up to 10% of the initial investment amount (limit) purchased within 1 year from the date of allotment, the exit load is nil. Afterward, it is 1%. For within 10% of initial investment, it is nil. The minimum lump sum required for this fund is ₹5,000. It is a very high-risk fund with a trailing return of one year of 37.44%. It has a NAV of ₹184.23, which has been consistently over ₹160 for the past year. The fund is 10 years old.

Edelweiss Small Cap Fund – Direct Growth

Kotak Small Cap Fund: Direct-Growth is a decent small cap fund with a total of ₹93,687 crores in Assets Under Management (AUM) as seen on 11th August 2022. This fund invests its assets in industries like Industrial Products (13.69%), Consumer Durables (8.12%), Banks (6.25%), Finance (4.89%), and Auto Components (4.53%). JB Chem and Pharm, Can Fin Homes, CCI, KEI Industries, and Navin Fluo International are among the top five Edelweiss Small Cap Fund – Direct-Growth small cap fund holdings. This fund operates at an expense ratio of 0.56%.

The exit load for units redeemed/switched out on or before 365 days from the date of allotment is 1% and nil afterward. The minimum lump sum required for this fund is ₹5,000. It is a very high-risk fund with a trailing one year’s return of 36.1%. It has a NAV of ₹26.05, which has been consistently over ₹21 for the past year. The fund is 4 years old.

Nippon India Small Cap Fund – Direct (B)

Nippon India Small Cap Fund – Direct (B) is a decent small cap fund with a total of ₹ 2,81,440 crores in Assets Under Management (AUM) as seen on 11th August 2022. This fund invests its assets in industries like Industrial Products (8.98%), Auto Components (6.65%), Consumer Durables (5.67%), Banks (5.51%), and Finance (4.53%). Tube Investments, Credit Access Grameen Limited, TREPS, KPIT Technologies, and HDFC Bank, are among the top five holdings of this fund.

This fund operates at an expense ratio of 1.04%. The exit load for units redeemed/switched out on/before completion of 1 month from the date of allotment is 1% and nil afterward. The minimum lump sum required for this fund is ₹5,000. It is a very high-risk fund with a trailing return of one year of 35.65%. It has a NAV of ₹95.09, which has been consistently over ₹75 for the past year. The fund is 10 years old.

Nippon India Small Cap Fund – Direct-Growth

Nippon India Small Cap Fund – Direct-Growth is a decent small cap fund with a total of ₹2,81,440 crores in Assets Under Management (AUM) as seen on 11th August 2022. This fund invests its assets in industries like Industrial Products (8.98%), Auto Components (6.65%), Consumer Durables (5.67%), Banks (5.51%), and Finance (4.53%). Tube Investments, Credit Access Grameen Limited, TREPS, KPIT Technologies, and HDFC Bank, are among the top five holdings of this fund.

This fund operates at an expense ratio of 1.04%. The exit load for units redeemed/switched out on/before completion of 1 month from the date of allotment is 1% and nil afterward. The minimum lump sum required for this fund is ₹5,000. It is a very high-risk fund with a trailing return of one year of 35.65%. It has a NAV of ₹95.09, which has been consistently over ₹75 since the past year. The fund is 10 years old. 

Union Small Cap Fund – Direct Growth

Union Small Cap Fund: Direct-Growth is a decent small cap fund with a total of ₹ 8,122 crores in Assets Under Management (AUM) as seen on 11th August 2022. This fund invests its assets in industries like Consumer Durables (9.27%), Auto Components (8.38%), Finance (7.89%), Healthcare Services (6.15%), and Debt (4.83%). TREPS, Home First Finance, Credit Access Grameen Limited, Tatva Chintan, and Krishna Institutes are among the top five holdings of this fund.

This fund operates at an expense ratio of 1.53%. The exit load for units redeemed/switched out before completion of 15 days from the date of allotment is 1% and nil afterward. The minimum lump sum required for this fund is ₹1,000. It is a very high-risk fund with a trailing return of one year of 34.24%. It has a NAV of ₹31.69, which has been consistently over ₹26 since the past one year. The fund is 8 years old.

SBI Small Cap Fund – Direct Growth

SBI Small Cap Fund: Direct-Growth is a decent small cap fund with a total of ₹6,48,641 crores in Assets Under Management (AUM) as seen on 11th August 2022. This fund invests its assets in industries like Industrial Products (18.49%), Consumer Durables (15.67%), Debt (12.8%), Construction and Others (7.2%), and Retailing (6.74%). TREPS, Elgi Equipments, Vedant Fashions, Sheela Foam, and Fine Organic are among the top five holdings of this fund.

This fund operates at an expense ratio of 0.76%. The exit load for units redeemed within 1 year from the date of allotment is 1% and nil afterward. The minimum lump sum required for this fund is ₹5,000. This is a very high-risk fund with a trailing return of one year of 33.13%. It has a NAV of ₹122.04, which has been consistently over ₹98 for the past one year. The fund is 10 years old.

Sundaram Emerging Small Cap Series VII – Dir Growth

Sundaram Emerging Small Cap Series VII: Dir Growth is a decent small cap fund with a total of ₹39,954 crores in Assets Under Management (AUM) as seen on 11th August 2022. This fund invests its assets in industries like Industrial Products (16.46%), Consumer Durables (12.52%), Debt (12.8%), Finance (7.92%), Auto components (5.62%), and Debt (5.38%).

TREPS, KSB, Crompton and Greeves, Navin Fluo, and Greenpanel Industries are among the top five holdings of this fund. This fund operates at an expense ratio of 0.97% and has no exit load. The minimum lump sum required for this fund is ₹5,000. It is a very high-risk fund with a trailing return of one year of 32.89%. It has a NAV of ₹22.16, which has been consistently over ₹17 for the past year. The fund is 4 years old.

Frequently Asked Questions

If you are looking for higher returns in a shorter period, you should invest in small-cap funds. Small-cap funds usually invest in the stocks of smaller companies that respond severely to market dynamics. As a result, these funds are high-risk. In the shorter term, the volatility may cause you to sustain losses in small-cap; however, if the fund performs well, the returns are exponential.

Experts believe that while small-cap funds are high-risk investments, you can invest in a few good small-cap funds for the long term instead of the short term. Long-term small cap funds can potentially outperform large and mid-cap funds, enabling you to get better returns and absorb market risks that tend to be highly effective to small cap.

Yes. Small-cap funds have low liquidity, making them unsuitable for investing in if you intend to improve your liquidity through investment. Additionally, small-cap funds are highly volatile and may cause you to sustain high losses if the market underperforms. It is best to carefully select the small-cap fund you wish to invest in and plan your investment in it.

On a long-term horizon, small-cap funds can perform better than other caps and give you great returns. With that said, on a 10-year timeline, you can dedicate 10% to 20% of your portfolio to small-cap funds, keeping the losses under control should the market become bearish.

You can begin investing in small cap funds online through websites like 5Paisa. These websites provide you with the right market analytics and information that helps you judge fund performance yourself and take a call for your investment. They also help with predictions that help you plan your investments better.

You can also invest in the stock of small-cap companies by creating a Demat account; however, this method is riskier.

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