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Table of Contents
A small-cap equity fund is an investment in company shares with market capitalizations below INR 5,000 cr. These companies are young and rapidly growing, which makes them technically unstable and prone to losses in the event of market turmoil.
Fund managers invest at minimum 65 % of their portfolios into small to mid-cap stocks within the Small and Mid Cap Mutual Funds. People unafraid to take risks and prefer positive returns over stability tend to favour small-cap stocks. The composition of small-cap funds is vital, and investing in them could be at risk due to impulsive decisions. Let’s look deeper at what is small-cap mutual funds meaning and other details in this article below.
Understanding Small Cap Fund Meaning
Mutual funds investing in companies with less than 250 stocks on the exchange are managed by small-cap mutual funds according to their market capitalization. Due to their high returns, small-cap mutual funds are a popular investment option.
The Small Cap Mutual Funds place their money in firms with low market valuations. All businesses ranked below the 250th spot are considered small-cap businesses by the Securities and Exchange Board of India (SEBI). Each company’s market capitalization will be used to determine the ranking. Small and medium-sized businesses have a market capitalization of less than 500 crores.
SEBI also requires that small-cap mutual fund schemes invest at least 80 % of their total assets in these companies. The Mutual Fund Scheme can invest in securities or equity-related instruments of small-cap companies. These funds have a very volatile nature and are subject to high risks. Even the slightest volatility in the market affects small-cap companies’ stock prices. But, as the company grows, these companies also offer better returns for investors.
It is easily understood that their share price will increase as small companies grow. To meet short-term investment needs, most investors opt for small capitalization schemes. It may not be a good idea since small businesses need time for growth. As a result, according to your risk tolerance and investment horizon, you can select smallcap funds. Theoretically, your risk appetite should be higher, and your investment period should be extended.
Who Should Invest In A Small Cap Fund?
The volatility of small and medium-sized companies is the driving force behind small and medium-sized mutual funds. They’re ideal for investors willing to take more significant risks than they might in the event of a higher upside. Only if you have an enormous appetite for risk will you consider investing in Small cap Mutual Funds. Remember, making returns when the market is down can be challenging. Aggressive growth in the financing of microcap companies should be considered.
Financial professionals recommend Diversifying your portfolio to prevent you from losing everything at once. For that reason, you must invest with care and include small or mid-cap funds in your basket. If your smallcap funds don’t work out, this will give you security. Most small-cap fund schemes invest at least 80% to 90% in smaller companies. Their remaining investments are in small and medium-sized enterprises. To allocate a small portion of your investment portfolio to these funds, it is necessary to identify the best Small cap mutual funds.
Advantages Of Small Cap Mutual Funds
The benefits of small-cap mutual funds are as follows:
1. Undervalued investments
Small-cap companies are underreported because most of them are not known. Due to this, there is a shallow level of analyst coverage. Small-cap mutual funds are a good investment option because they have a strong chance of being overvalued. Those investors who prefer a much higher risk profile than that of these companies will be able to benefit from them.
2. Low liquidity
Small-cap stocks are traded on a thin stock market. However, it is considered a drawback by some investors. For investors who are expecting the potential of a company, it is, in fact, advantageous. Many investors may be interested in the stock once its earnings and revenue have been reported by management. The prices are rising rapidly because of strong demand and the limited supply of shares on the market.
3. Higher growth potential
When investing in new companies with more scope for expansion, small-cap funds have high growth potential. Compared with larger companies, these firms can expand their activities.
4. Diversification benefits
It helps to make a balanced risk-return trade-off when you add small-cap funds to your total portfolio. Therefore, these funds allow diversification of investments, reducing your risk level.
5. Merger and acquisition possibilities
With smaller companies, there is a higher likelihood of mergers and acquisitions. They can be acquired or merged with their bigger counterparts to grow naturally. Therefore, small to medium-sized companies can be expected to see their shares increase and eventually impact the value of smaller-cap funds.
Drawbacks Of Small Cap Fund
The limitations of a small-cap fund are as follows.
1. A high volatility
Small-cap stocks will be affected if market sentiment turns weak. In volatile markets, small-cap schemes tend to fall. During such times, stock price volatility is higher for small-cap companies.
2. Do not pay dividends
Small-cap companies are relatively young and generally do not pay dividends. They tend to reinvest their profits in it, as they are required to expand their business. Therefore, it is impossible to draw upon smallcap funds as sources of income from dividends.
3. High risk factor
Risks are more common for small-cap enterprises. Most of the time, they fail to weather economic crises or downturns. Many small-cap businesses fail while attempting to compete with their larger rivals. Additionally, such companies may experience a significant decline in the value of small-cap funds. As a result, they are not a good investment choice for cautious investors.
4. Timing of investment
Market volatility influences the timing of buying or selling a small-cap mutual fund. Within a short period, the ups and downs of the market can make or break a small-cap fund.
Things To Consider Before Investing In Small-Cap Fund
Investors are advised to consider all factors that affect the performance of small capitalization funds, as they carry significant risks on the market.
1. Investment risk
The best small-cap funds are exposed to risks but deliver excellent returns. To achieve high returns, you must consider funds that beat the benchmarks of the smallcap index and other Small Cap Fund.
2. Taxation
The holding period, or when an investment was kept, determines how much capital gains are taxed when small-cap funds are redeemed. Redeemations held for up to a year result in short-term capital gains (STCG), which are taxed at 15%. Long-Term Capital Gains (LTCG) are gains from holding periods longer than a year, and a 10% tax is applied on amounts over one lakh rupees.
3. Returns on investments
Small investment trusts generally deliver high returns and may be an essential part of the portfolio. These funds can serve as buffers in an investment portfolio with a high level of risk, providing outstanding value when the market is performing well.
4. Investment costs
Small-cap equity funds are linked to costs, so your investment is well managed. It’s known as the fund’s cost ratio. The cost ratio of the Fund is limited to 2.50% according to guidelines issued by SEBI. You should consider the net profit after expenses when selecting a fund.
Conclusion
You can quickly invest in a fund that internal experts have carefully chosen. Once your long-term company needs have been determined, you can expand your portfolio by making small capitalization investments. You must be adequately knowledgeable about the financial markets to make investments, or you must have professionals advise you on the dangers and potential rewards. For safe and secure trading and investment, use trading platforms like Share India.