Small Cap Funds

Small-cap funds are one of the types of mutual fund. The Cap stands for market capitalization, meaning the total market share of any publicly traded companies. So, market share is determined when the total number of outstanding shares are multiplied into market price per share (eg. If ABC Ltd has total 5 Cr shares valuing at Rs. 25/- each, the market cap of ABC Ltd = 125 Cr). Now small-cap, as the names suggest means, funds which target companies with small market capitalization. The manager aggressively invests over 60% of the funds in small-cap companies, with high potential. However, with higher potential, they also incur higher risk and volatility. Generally speaking, small-cap companies are start-ups or IT companies with good potential, which can fetch enormous returns in small time. Speaking of returns small-cap funds returns hover around 18-30% in a five-year tenure. Let us check out top performing small-cap mutual funds.

Top performing small-cap funds

1. SBI Small Cap Funds

One of the top performing funds, where over 90% of the fund comprise of equity stakes and in that around 58% comprises of small cap companies. The fund has provided extraordinary returns in 5 year tenure, touching almost 30% in that period.

2. HDFC Small Cap Fund – Direct – Growth

One of the largest fund in its category with over 6000 Crores of fund size, it has consistently outperformed its benchmark of NIFTY Small cap 100 TRI. Equity stakes of have been dominant in its holding with over 50% investment in mid-cap entities while above 25% in small-cap companies. The return has consistently been over 20% over a period of 3-5 years and above.

3. Reliance Small Cap Fund – Direct – Growth

Among one the largest funds when compared to fund size, this fund is popular due to its lowest cap on SIP value i.e Rs. 100. This fund is considered highly risky.  However, it has not disappointed the investors as it has given good returns reaching reaching over 26% in its tenure. This fund is a mix of small and mid-cap companies, with a total of over 90% of fund amount invested in equity stake.

4. Aditya Birla Sun Life Small Cap Fund – Direct – Growth

The performance of this fund was below par last year as it failed to even match its benchmark. However the fund still manages to be in the top small cap funds because of its potential to outperform its rival. No debt content its portfolio, this fund has targeted financial service, manufacturing and consumer goods sector predominantly.

5. L&T Emerging Business Fund – Direct – Growth

One of the youngest fund in this list, yet fetching over 5000 Crores in mere four year tenure, L&T emerging fund is the fund to watch out for. As the name suggest, the fund targets challenging avenues with high potential. However the poor performance was poor last year this fund if given time can help unlock small cap companies as well as investors wealth potential.

Things to watch out before investing in Small-cap Funds

Small-cap funds always involves certain amount of risk, but a bit on the higher side as compared to other funds, therefore it is always wise to diversify your investment in different funds and not concentrate all of them into small cap. Let us look at things to lookout for before investing.

a. Past performance of fund:

This is very important aspect before choosing the right fund. The past performance mean, not the very recent but the overall performance in its tenure which shall includes all types of favorable and unfavorable conditions. Therefore when evaluating a fund, one must look at its performance in poor conditions and at the same time check how its nearby funds have performed.

b. Quality of manger & fund house:

Again very important to determine who are you handing your hard earned money to? More experience, a good research team, technique to dodge risk are some of the qualities to be watched out while choosing the fund house and manager. A small-cap fund usually requires manoeuvring of funds from equity to debt in case of high market volatilities or a switch in between cash and equity. This manoeuvring requires a skilled manager and fund house to handle the situation at right time.

c. Don’t put all eggs in one basket

Returns on small-cap funds can tempt anyone to invest heavily in small cap, but that would be a very risky business. Even though small-cap funds generate extraordinary returns, it is never recommended to put a major part of your savings in them, due to its inherent high risk nature. Therefore, the portfolio should have the right mix of high and low risk.

How to evaluate the best small-cap mutual funds?

An investor needs to understand, the basics of mutual fund in order to evaluate the best among best. Let us check out what these basics are.

i. Standard Deviation:

This is a tool which denotes the amount of volatility associated with the fund. High volatility equals higher risk and vice versa. Therefore, while choosing any small-cap funds one needs to identify the fund with the lowest standard deviation. Small-cap mutual funds are generally highly volatile. However, while evaluating the same, choose the one with low standard deviation amongst its identical siblings, because small or mid-cap funds cannot be compared with large-cap funds as the basis of evaluation is completely different.

ii. Sharpe Ratio:

This is a measure to ascertain the risk-adjusted return of the fund. In layman’s term higher the sharp ratio the better.

Sharp Ratio  =                 Average fund return – Risk-free rate
______________________________________
Standard Deviation of fund

iii. Beta:

This is nothing but a measure to check the sensitivity of the fund to its benchmark. Mutual funds derive their value via its underlying benchmark. Therefore in order to co-relate the fund’s movement with its benchmark the tool called beta is used. When a fund as 1.0 beta, it means the fund and its benchmark movement are 100% identical. Beta also require the help of shape ratio in order to be accurate in its result.

iv. Alpha:

Alpha helps to determine the ability of the fund manager to gain profit, as per the performance of the benchmark. Therefore higher the alpha, better the performance of the fund and vice versa.

Advantages of Small-cap funds

a. Returns:

As said earlier, the returns derived from small-cap funds are extraordinary when compared to any other fund or investment option. Small cap fund returns range from 18% to 30% in five-year tenure, which is substantial.

b. Overlooked option:

Due to its high volatility, these funds are overlooked by institutional investors, which paves the way for tapping high potential options for small investors.

c. Diversification:

Small-cap funds provide a great deal of diversification and can be useful when large-cap funds do not perform up to their usual standards. Even during the time of the bearish market, these funds are capable enough to perform and provide the cutting edge in your portfolio.

Disadvantages of Small-cap funds.

a. Risk:

Small-cap funds are highly risky investment options, considering the nature of stocks they invest in. Small-cap funds target those companies which do not have proven track record and have a small or little market capitalization. Thus, small-cap funds are based on the principle of high risk equals higher gain.

b. Not everyone’s cup of tea:

Small-cap funds are only for the risk takers or investors with high-risk capacity. Therefore, novice investors or investor in their retirement should not possibly invest in these funds.

c. Fund Manager:

The fund manager or fund house plays the role of utmost importance in a small-cap fund as their decision making is directly proportionate to the performance of the fund. Therefore, there always is a dependency over the fund manager and their knowledge, which may at times creat some hindrance in choosing funds.

Who should invest in small-cap funds?

Extra-ordinary returns are an unavoidable lure of small-cap funds. However, it is not everyone’s cup of tea. It is advisable that new investors or investors who are in their retirement or close to it should generally avoid investment in these funds. Risk is associated with all investment options. However, in the case of small-cap funds, it is of significantly high. Completely avoiding small cap funds from your portfolio could prove costly in the long run due to its dream like returns. Therefore, a seasoned investor who have their risk covered in other options, could opt for small-cap funds. Patience is the key to any investment option, and small-cap funds are no different. Hence, one must avoid hasty decision of wrong switching or faulty redemptions and stick with fund until these funds show their performance. One more important point while investing in small-cap funds is to avoid considering small-cap fund as the emergency fund option, because emergency may not necessarily fall in a favorable market scenario.