Category : New to Investing February 3, 20265 minutes read
Small cap mutual funds invest primarily in stocks of small cap companies, i.e., businesses that are still in the early stages of growth and ranked below the top 250 companies by market capitalisation. While these funds carry higher risk due to greater volatility and lower liquidity, they also offer the potential for higher long-term returns. Small cap funds can be actively or passively managed. Active funds rely on fund managers to select stocks with strong growth potential, whereas passive small cap index funds aim to replicate the performance of a specific small cap index. Understanding how these funds work, their risks, and their suitability for long-term investors is essential before including them in an investment portfolio.
Small cap mutual funds are a type of mutual fund scheme that invests primarily in stocks of small cap companies. As these funds invest in only one market cap, they are higher in risk; however, due to their investment strategy, they have the potential to generate higher returns. Beginner investors must understand how small cap funds work before deciding whether they fit into a long-term investment strategy. Moreover, there are two types of small cap mutual funds, active and passive. Active small cap mutual funds aim to outperform their underlying index and adopt an active investment strategy, whereas passive small cap funds or small cap index funds track an underlying index and aim to replicate the returns.
Small cap funds in India are equity schemes that are mandated by SEBI to invest at least 65% of their assets in small cap equities. These equities belong to small cap companies. which are ranked below 250 on the Nifty market index. Typically, these companies are in early stages of their growth, and while they may not be industry leaders, they often have the potential to grow faster than larger, more established companies.
While 65% of the fund portfolio is mandated to be invested in small cap equities, the remainder of their total assets can be invested in other equities, cash, or debt instruments for diversification and liquidity management.
Small-cap mutual funds are actively managed by Asset Management Companies (AMCs). The AMC identifies small companies with strong growth potential, sound management, and sustainable business models. Generally, the stocks are researched before investing in them, and financial statements, management quality, and growth prospects are analysed. These are factors that investors may consider in their analysis of a small-cap fund before investing. AMCs then select stocks of companies that are expected to outperform over the long term, and the portfolio is regularly reviewed and adjusted based on market conditions.
Stock selection is a crucial part of a small-cap fund, as performance is largely dependent on how well the company performs and whether it is able to withstand market volatility. A well-managed small-cap fund may outperform its benchmark over time, while poor stock selection may lead to underperformance or losses.
Small cap index funds track an underlying small cap index and aim to replicate its returns. These schemes are similar to small cap mutual funds, wherein they invest primarily in small cap companies. However, while AMCs influence stock selection in small cap mutual funds, stock selection in small cap index funds is determined by the underlying index.
Small cap index mutual funds may track small cap indices such as the Nifty 250 index or the Nifty small cap 100 index. Additionally, a lower expense ratio is common in small cap index funds as they adopt a passive investment strategy and have lower management costs.
Start a passive investment by investing in Bandhan Nifty Smallcap 250 Index Fund.
Here are some features of small cap funds:
High-Risk-Return
Small cap funds are a high-risk-return scheme. This is inherent due to their asset allocation in small cap equities. Small cap equities are generally new to the market and do not have a well-established strategy or financial assets, making them vulnerable to market risk and fluctuations.
Read more about investment risk.
Lower Liquidity
Although small cap mutual funds do not have a lock-in period, small cap stocks generally trade at lower volumes and have lower liquidity. This may lead to higher price fluctuations during market stress.
Long-term Investment Horizon
Small cap mutual funds are suitable for investors who have a long-term investment horizon. Small cap companies are new and take some time to grow and perform. Consequently, investors must remain invested for a longer time to gain potential returns.
Invest in Bandhan Small Cap Fund today to reap the potential benefits in the long-term!
There are largely two types of small cap funds – active and passive. Actively managed small cap funds select small cap stocks and aim to outperform their underlying index. Passively managed small cap funds track an underlying small cap index and aim to replicate its returns. In general, small cap funds are high-risk-return schemes, have lower liquidity, and are suitable for investors with a long-term investment horizon.
