Small cap is the category of mutual fund which is designed to give better returns in very long term, say at least more than 10 years. They are known as small cap due to their market capitalisation. They have market cap of less than ₹ 500 crore. Small-cap funds are presumed to have significant yet hidden potential to be a 'multibagger' one day. However, one should be aware of this fact that this kind of schemes remain very much volatile in short horizon, which may scare you.
Small cap funds are highly risky and volatile investment instruments as compared to large and mid-cap fund category due to their exposure in high performing equities. In a Small-Cap fund, fund manager can have exposure to stocks of small companies in the range of 65%-90%. These funds have an objective of seeking capital appreciation through investment in high growth stocks. These kind of funds are suitable for investors who are willing to take high amount of risk with their capital compared to blue-chip companies.
So, here are few things to consider while investing in small cap funds.
Research: If you wish to succeed in earning good returns from small-cap mutual funds, you need to spend time in researching about it as well. The ones with a proven track record over a period of time are the ones that you should ideally prefer.
Invest for long term OR focus on long-term gains: As small cap funds are volatile, one may not observe growth in short run, hence investing for a longer time is essential to know the growth pattern of the fund. It has been observed that it takes three to four years for these companies to show superior performance. It is essential that investors should have a long-term horizon in mind if they are to invest in these stocks.
Check your risk appetite: If one does not have the financial cushion to handle the fluctuating economic conditions, then it is advisable to not go for small cap funds
Diversify the portfolio: If small cap funds are hit by the market conditions, one should be ready to bear the loss by keeping a mix of mid cap and large cap funds in the portfolio.
Fund house quality: Running behind the brands does not ensure the success in the small-cap market. You need to explore and pick small-cap schemes from a fund house which have shown benchmark-beating performance across market cycles. Invest with a fund house having a well-defined investment process and risk management techniques. A seasoned in-house research team and large coverage universe make a fund house trustworthy.