Unlocking The Potential Why Investing In Small-Cap Funds Is A Smart Move

Small-cap funds often catch the eye of investors looking to capitalise on high-growth potential and impressive returns. While they are known for being volatile, these funds cater to those prepared for calculated risk-taking.

By investing in lesser-known, emerging businesses with significant growth potential, small-cap funds offer a unique opportunity for investors with long-term goals and a high-risk appetite to diversify their portfolios and tap into promising future gains.

High growth potential

The benefit of small-cap funds is the enormous growth potential they offer. Small-cap funds are equity mutual funds that invest at least 65% in stocks of small-cap companies; companies having a market capitalisation of less than INR 5,000 crores qualify as small-cap companies. This means they have a significant scope for growth and expansion compared to the already established corporations.

When an investor invests in small-cap funds, they are betting on the fact the company will be a success in the future. Taking historical data into account, the best-performing small-cap funds tend to outperform large-cap funds in the long run. According to an analysis of mutual fund performance, small-cap funds have given the highest average returns of around 30.62% and 20.45% in the last five and 10 years.

Thus, they have the potential to deliver faster revenue growth and adapt quicker to market changes, compared to large-cap and mid-cap companies.

Diversification within the portfolio

Small-cap funds help investors achieve diversification within their mutual fund investment portfolio. Investors tend to hold mid and large-cap funds as they are stable and low risk investments compared to small-cap funds.

However, small-cap funds diversify by spreading investment across companies with a lower correlation to large-cap market movements. This might help in potentially reducing overall portfolio volatility. Small-cap companies revolve around domestic markets, they might be less affected by global economic fluctuations, while large-cap companies tend to be highly impacted by international turmoil.

Capitalising on market inefficiencies

Small-cap stocks often receive less analyst coverage compared to large-cap stocks, creating potential blind spots in the market. Skilled fund managers can leverage these overlooked areas, identifying undervalued small-cap stocks to capitalise on price discrepancies. By tapping into these market inefficiencies, fund managers can unlock value for investors, seizing opportunities that might otherwise remain hidden.

Opportunities for active management and expertise

Limited research and coverage on small-cap stocks can make it challenging for retail investors to make informed choices. However, experienced fund managers, skilled in identifying high-potential small-cap companies, can help investors tap into these opportunities. Through in-depth research and analysis, these managers strive to build favourable risk-reward profiles for investors. For those with the capital but lacking the time or expertise for extensive analysis, a well-managed small-cap mutual fund offers a convenient, professional investment solution.

Considerations for small-cap investments

While the potential gains of small-cap funds are appealing, investors should approach these investments with caution, fully aware of the risks. Small-cap funds may offer higher returns than large-cap funds but are also subject to greater price volatility. During market downturns, small-cap companies, often lacking robust financial reserves, can be hit harder than larger corporations.

To manage this risk, investors can diversify across different types of funds within their portfolios. Investing through a Systematic Investment Plan (SIP) is another way to mitigate risk, as SIPs spread investments over time, reducing the need to time the market.

Additionally, investors should periodically review their portfolio’s performance against long-term financial goals. Patience is essential, as small-cap companies typically take time to grow and deliver returns.

Conclusion

Small-cap funds can be a compelling addition to a mutual fund portfolio, offering high growth potential, valuable diversification, and the power of compounding to investors focused on maximising returns.

While the risks are indeed higher, expert fund management can help navigate these challenges and create opportunities for substantial returns. For investors with a high-risk tolerance and a long-term outlook, small-cap funds may be a strategic move towards achieving financial goals.