When it comes to making investments, there are a lot of options for people to invest in. The primary aim of investing is to grow capital so that it reaches the investor’s goals. When it comes to investments that grow fast, equities top the list.
Investing in equities can get tedious for an investor since it requires a fair amount of study and research about the company and the sector that it operates in. To reduce the risk involved, one alternative is to invest in equities through mutual funds. Mutual funds are vehicles that pool resources from investors and invest the funds in a range of assets. These assets may be equity shares, fixed income instruments, corporate bonds, government securities, money market instruments etc.
The alternative for people looking to invest in equities is to pick an equity mutual fund. Depending on the type of equity shares that the mutual fund house invests in, they can be classified as:
• Large cap mutual funds
• Mid cap mutual funds
• Small Cap mutual funds
What is Small Cap mutual funds?
Small Cap Mutual funds are funds that invest primarily in Small Cap stocks. Small Cap stocks are those shares which are ranked beyond 250 in terms of market capitalization. These are generally small companies which are fast growing in their business. Their business may or may not be established just as yet, which means they are a risky proposition to invest in. This is because their value depends more on their performance and on external factors driving their business.
As such, even though Small Caps are risky, they are an excellent investment opportunity since they can grow in terms of value and market capitalization in the medium to long term. Whenever Small Cap stocks show growth, they tend to outperform large caps. However, when the markets fall, Small Caps are impacted first.
Small Cap stocks started becoming more popular off-late when inflated valuations compounded investors’ returns in just a few months. However, these stocks have taken a beating in the year 2018 and have broadly underperformed the market in the year 2019. But does that mean one should stay away from Small Cap stocks?
The best way to invest in Small Cap stocks is to pick out Small Cap mutual funds. Small Cap mutual funds reduce the risk since they invest in a range of Small Cap stocks. However, since Small Cap mutual funds are managed by a professional manager, these picks are based on research and company fundamentals as opposed to cherry picking.
When should you invest in Small Cap funds:
1. If you have a high risk appetite:
Small Cap mutual funds are highly risky. Their performance is very sensitive to market movements. These funds give tremendous growth when the market is in a bullish phase but during a bear phase, they show negative returns i.e. loss of invested capital. In case you can’t bear that high risk, invest in small amounts or invest in safer large cap funds that have lower returns but provide much better safety of invested capital.
2. If you have a long investment horizon:
Investing in Small Caps is not a strategy for the short term. Since Small Cap mutual funds are sensitive to market movements, any short term bear phase may pull their value down. This may not necessarily reflect their underlying value or the performance of the stocks that they hold, but it can lead to negative returns as most funds experienced in 2018. Small Cap mutual funds are long term investments. The top Small Cap mutual funds provide inflation beating returns over the longer term when short term fluctuations even out.
How to pick the best Small Cap mutual fund for investment:
Small Cap mutual funds 2019 have shown growth as compared to the fall in 2018. Funds that have invested in good quality stocks showing good business fundamentals are showing good returns. Top Small Cap mutual funds are showing returns and have turned attractive for investors once again.
1. Check their past performance:
While the past performance of a fund is no indicator of the future growth potential, it can speak volumes about the stocks that comprise the portfolio. If the mutual fund has not fared badly in a bearish market, it is testament to the quality of stocks in its portfolio. Compare the past performance against the growth of the broader Small Cap indices to make a decision.
2. Check their expense ratio:
The expense ratio is the ratio of total expenses incurred by the mutual fund against the total assets of the fund. A high expense ratio means a larger portion of the assets are being used to fund administrative and selling expenses. This does not translate into a higher return for the investors. The best Small Cap mutual funds do not have high expense ratio. The expense ratio limits as per SEBI depend on the assets under management (AUM):
• 2.25% - AUM of Rs. 500 to Rs. 750 crores
• 2% - AUM of Rs. 750 to Rs. 2,000 crores
• 1.75% - AUM of Rs. 2,000 to Rs. 5,000 crores
• 1.5% - AUM of Rs. 5,000 to Rs. 10,000 crores
• A 0.05% reduction for every Rs. 5,000 crore increase in AUM
• 1.05% - AUM above Rs. 50,000 crores
Checking the expense ratio against the ceiling is a good way of finding the right mutual funds.
3. Look into their sectoral allocation of funds:
Checking which sectors the mutual funds invest in can be helpful in deciding where to invest funds. If the mutual fund is investing funds in highly risky sectors that are going through turbulence, then that will not translate into good results for the fund and consequently, your investment.
4. Entry or exit loads:
Entry loads reduce the amount invested whereas exit loads reduce the net return on your investment. It is essential to pick a fund that has no exit load or one that has low exit load so as to get maximum returns on your investment.
Here is a list of top Small Cap mutual funds that research experts at IndiaNivesh Wealth Management recommend to have as a part of your portfolio.
Investing in Small Cap stocks can be a risky affair. A good broker house like IndiaNivesh can help you with good research reports that can help you invest in Small Cap mutual funds. So why wait, open a demat account with IndiaNivesh and enjoy the benefits that it has to offer.
Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.