Small Cap Mutual Funds- Market Scenarios- Where They Are Favourable?

A Small Cap Mutual fund investment refers to investing in small market capitalized companies with high growth potential. In the long-term goal, Small Cap funds have the potential to generate superior returns. These funds invest the maximum part of their investment corpus into Equity tools of small-cap companies. The market capitalization of these small-cap companies is ranked below 250 as per the Securities and Exchange Board of India.

An investment strategy for a Small Cap Mutual Fund in India -

1. 65% of the total fund corpus from your portfolio can be invested in small-cap companies. These funds help in the growth of various equities associated with it, to achieve an optimal investment portfolio.

2. The fund manager constructs the portfolio by combining the top-down and bottom-up construction setup. Here, the fundamentals of each stock and the management quality are focused.

3. Now, the portfolio must be diversified by the fund manager. This suggests exposure of the portfolio to other companies with large to medium capitalization. But the larger part should be in the Small-Cap companies.

4. Not only in assets, but these funds also requires investment in debt and money market securities.

5. The fund manager can also add investments in other schemes lead down by the fund house to meet the investment goal even in an adverse situation.

Before you invest in a Small Cap Mutual fund, you need to know that these are associated with higher levels of risk. A little volatility in the market may make a huge impact on the returns and share prices. But, then again, you have a greater scope to grow your capital in the long run. With short-term investment goals, if you buy Small Sap Mutual fund online, then it is not a good choice, as small-cap companies need time to grow.

While investing in a Small Cap Mutual fund, you need to remember the following aspects:

@ Risk factor - The NAV of these funds are highly associated with fluctuating market conditions. This means if the market conditions are not good, then investing in a small-cap fund may cause severe losses. Any investor who is having a high-risk appetite can invest in small-cap funds.

@ Returns - The returns from these funds are relatively higher in the long run. It is also said that these funds have the potential to return more than 100% in a single day.

@ Expense Ratio - Look for lower expense ratio schemes. Expense ratio refers to the charges asked by different fund houses according to your total assets, for managing your funds. The lower the expense ratio, the higher is your returns.

@ Long-term investment goal - These funds are sensitive to market fluctuations and need time to grow. Therefore, to generate higher returns, you must have long-term goals i.e. 8-10 years or more.

@ Check the fund record - See how the small-cap mutual funds had dealt with adverse market situations to understand its downside protection against any fluctuation in the market.

To enjoy wealth appreciation, investors need to wait patiently for a longer period and must have a good risk appetite. Note that, these schemes do not guarantee any returns and therefore your investment objective may not be achieved.

The returns from these funds are subjected to dividend distribution tax and capital gains tax. A Dividend Distribution Tax or DDT of 10% is deducted by the fund houses before paying out your dividend. Capital gains tax is charged on an investor when they sell an investment tool and make a profit. If the holding period of these funds is less than a year then 15% short term capital gain tax is charged. And if the holding period of the funds is more than a year, then 10% Long Term Capital Gain tax is charged for gain amounts above Rs 1 Lakh. If the LTCG is below 1 lakh, you can enjoy a tax exemption.

Never make small-cap schemes form the core part of your portfolio. As they go through severe ups and downs along with market fluctuations. Moreover, you don't get an assurance of stable returns. Therefore a well-diversified portfolio is recommended to reduce the risk factor and increase the chances of better returns. There is a myth that small-cap funds are of inferior quality in comparison to large-cap mutual funds, but no, only higher revenues and profits don't create a quality fund. Another myth says these funds are good in the bull market and bad in the bear market. Generally, an investor prefers to buy a stock when its price falls and sell it when the price rises. But it is not possible to create the best market timing while investing. Therefore it needs a systematic approach to investing through SIP. When market conditions are unpredictable, investors can diversify their portfolios according to the risk appetite.