Small Cap Mutual Funds: Things you must know

In discussing Equity Mutual Funds, it is crucial to know the market capitalization of organizations. In basic terms, market capitalization is the estimation of the organization, which is traded on the stock trade exchange. 

The calculation is basic – you multiply the current share price by the total number of outstanding shares. It is a vital aspect that can assist investors in deciding the profits from a share and the risks involved. 

In light of market capitalization, mutual fund schemes are sorted as large-cap, mid-cap, small-cap, and multi-cap schemes. 

Here, we will investigate Small Cap Mutual Funds and understand the different perspectives that one should know before investing in them.

What are Small Cap Mutual Funds?

Small-Cap Funds contribute a significant part of their investible corpus into equity or equity-related instruments of small-cap organizations. As per the Securities and Exchange Board of India (SEBI), small-cap schemes need to invest at least 65% of their total assets in small-cap organizations. 

Likewise, SEBI describes small-cap organizations as those which are positioned below the 250th rank in terms of market capitalization. In financial terms, these are organizations with a market capitalization of not more than Rs. 500 crores. 

It is important to note that small-cap funds bear a high level of risk. Indeed, even the smallest instability in the market can hugely affect the share prices of small-cap organizations. In any case, these stocks additionally have great potential to bring remarkable returns. 

Consider the big picture – a small organization has a lot of scope for growth, and when it grows, the share price would increase significantly. In any case, numerous investors will, in general turn towards small-cap schemes for short-term investment needs. 

This can be useless as small organizations need time to grow. Henceforth, it is normally prescribed to choose small-cap funds if you have a higher risk appetite and a long investment horizon.

Characteristics of Small Cap Mutual Funds

Small-Cap Mutual Funds allow investors to earn profits from growing companies. While institutional investors are heavily invested in more stable funds, individual investors can pick some of the best small-cap growth funds, small-cap value funds, and small-cap index funds to earn better returns.

They are ideal for aggressive investors who seek higher returns and are happy with high risk. It can be considered a bit unfair that small-cap companies end up getting a lot of harmful media attention due to the failure of a few companies. So, small-cap mutual funds deliver an opportunity to invest in such companies while ensuring that your capital is invested in the right companies.

Some other features of the small-cap mutual funds are listed as follows:

• Small-cap mutual funds put resources into small-cap organizations. These include start-ups or small-income organizations that are in the beginning phases of development.
• The organizations that small-cap mutual funds invest in have a high growth potential later on.
• Small-cap funds are unstable in nature. This is on the grounds that small-cap organizations are not financially steady. They are additionally not as established as bigger firms.
• Small-cap funds are risky. They can create incredible returns for investors searching for dynamic growth and who have high risk-taking limits.
• Small-cap funds generally beat mid-and large-cap mutual funds during a bull market. A bull market is when share prices rise, which empowers purchasing.
• The performance of small-cap funds diminishes considerably more than mid-and large-cap funds during a bear market (when share prices drop, which empowers selling).

What to remember before investing in Small Cap Mutual Funds?

Now, as tempting as investing in small-cap mutual funds can seem, it is important for any investor to keep in mind certain parameters before deciding to invest. Some of such parameters are as follows:

• Your Risk Appetite: Small-cap Mutual funds face high market risk. Any changes in the market will reflect a change in the fund's net asset value (NAV). At a point when the market as a whole isn't performing great, the small-cap fund will in general experience a fall. Amid market instability, smaller and less-established organizations may also leave the business. Then again, when the market is progressing nicely, small-cap funds have an incredible capacity to deliver more outstanding returns than other mutual fund types. If you, as an investor, have a high-risk appetite, you can choose small-cap funds.

• Check The P/E Ratio: The P/E ratio will give you a view regarding the fundamental growth ability of the fund. It will likewise let you know by how much your fund is overpaying for growth. Small-cap mutual funds having a P/E ratio of above 30x - 40x are inspected as costly.

• Your Investment Return: Small-cap mutual funds have lately done well in the Indian market. If you can survive risk and need investments that show powerful growth, small-cap mutual funds can be ideal for you. These funds have the capability to give returns of over 100% in a single day. However, one must not forget the risks associated.

• Returns Must Be Risk Adjusted: There is no dilemma that small-cap funds carry risk; however, there are reserves that can manage risk in a way that is better than its peers. Investigate choices and their ability to gather good returns from different schemes with low instability.

• Your Investment Horizon: Small-cap funds face a critical decline in returns when the market is going down. Thus, to produce great returns, you have to have a long-term investment horizon. This implies that your investment should keep going for 7-10 years. Historically, small-cap mutual funds give a more significant return when you have a long-term investment plan.

• Your financial goals: Small-cap mutual funds invest in organizations that have a high potential for generating extraordinary returns. Along these lines, if your risk appetite is large, small-cap funds might be ideal for you. It would be a smart thought to have some long-term financial goals as a primary concern when investing. Your financial objectives could be putting something aside for retirement or paying for your kids' schooling, wedding, etc.

How to Reduce Risks?

As mentioned previously, small-cap mutual funds carry higher risks as compared to their peers, but they can also generate higher returns. As a result, in order to attain those returns, one must be prepared to endure the risks and try to reduce them. The following are some ways that can help reduce the risks associated with investing in small-cap funds:

• Invest energy in exploring small-cap funds. Funds with a confirmed record of more than five years are acceptable.
• Expand your portfolio, so your losses are negligible when the markets are low. A healthy blend of investments will go about as a cushion against misfortunes. You may even get great returns in different areas of investment when small-cap funds fail to deliver profits.
• Try not to time the market, as it is unsafe and unreliable. Anticipating the market is extremely troublesome. If you turn out wrong in your expectations, it could prompt losses.
• Try not to purchase or sell in a rush due to market gains or losses. Both short-term gains and losses in small-cap mutual funds could be for a short period. Invest for the long term to overcome market instability.
• Attempt to go for reliable no-load mutual funds. 'No-load mutual funds are funds with no commission or sales charge. It very well might be hard to track down such funds, yet it deserves a shot.
• Put resources into small-cap mutual funds through a systematic investment plan (SIP). It will average out the cost, along these lines decreasing volatility.

What about taxation?

You realize capital gains after redeeming units on small-cap mutual funds. Capital gains attract tax collection. Be that as it may, the rate of tax assessment relies upon your period of investment in the fund. This is the holding period. 

Capital gains acquired during a holding period of as long as a year are temporary capital increases. They draw in 15% tax. Long-term capital gains are gains obtained on a holding period of more than a year. Long-term capital gains of over Rs 1 lakh have a tax collection rate of 10%.

The fund house has to deduct a DDT of 10% before paying the dividends.

Who should invest in Small Cap Mutual Funds?

Small-cap funds are known for their capability to offer exceptional returns. They have a higher likelihood of beating the benchmark when the markets are bullish. In any case, when the markets enter a slump stage, the NAV of the funds gets influenced altogether. 

If you are prepared to take some risks to enhance the profits on your portfolio, you can decide to invest in small-cap mutual funds. Investing a small bit of your portfolio in small-cap mutual funds for the long term is a great method for producing great returns.

Best Small Cap Mutual Funds in 2020

Conclusion

We see through the article that small-cap mutual funds are basically where the money is invested in companies below Rs. 500 crore market capitalization. Investors who invest in small caps are basically the ones with the hunger for more returns but the risk that accompanies it is also big.

Finally, before investing in Small-cap mutual funds, one must keep in mind the amount of risk they can handle, and their financial objectives and should always check the P/E ratio. These are some parameters one should always keep in mind before deciding to invest in lucrative, but risky small-cap mutual funds.