One of the numerous mutual fund variants available is equity mutual funds. As the name suggests, equity funds invest in the equity market. However, it is imperative to note that equity funds are not a monolith. An equity mutual fund investment can be large-, mid-, and small-cap funds. While large- and mid-cap funds are equity funds with comparatively lower risks, small-cap funds have higher risk levels.
What are small-cap funds?
Small-cap funds are the funds that invest in stocks of businesses with small market capitalisation. These small-sized companies have the potential to grow and deliver higher returns. As they are a type of equity funds, small-cap mutual funds are high-risk-return investments. So, invest in a small-cap fund if you have a high-risk appetite.
How do they work?
Small-cap stocks are the stocks beyond the top 250 companies in the SEBI list. These stocks are of companies that are usually unheard of. Fund managers look at such small-cap stocks that perform well in the market. Sometimes, they have even outperformed the benchmark large-cap stocks and indices. Fund managers invest in such stocks that may deliver good returns to investors. A small-cap fund investor leverages over small-sized companies. Small-cap funds can provide high returns in the bull markets if small businesses grow up to their full potential. You must consider a few factors before investing in these funds. Those factors are:
- Your risk tolerance:
These equity mutual funds allocate funds to the stocks of companies with short boom and bust cycles. Therefore, they are suitable only for aggressive investors, i.e. investors who know when to enter and exit their investments. You must time the markets to maximise your returns.
- Fund track record:
You must check the track record of a small-cap fund before investing in it. Check the performance of the small-cap fund during both bull and bear markets. Check the fund performance during the bear market, as it will provide an idea of the reliability of the small-cap fund.
- Portfolio composition:
Checking the portfolio composition is prudent and mandatory. Don’t invest in a small-cap fund without checking its portfolio composition. Every AMC provides detailed information about the mutual fund scheme’s portfolio composition. You can access this information on the official website of the AMC.
- Check the reputation:
Consider AMCs and managers who are experienced in managing small-cap schemes. Remember that investing in small-cap funds is risky and challenging. One must identify promising companies, purchase stakes well in the company advance, and hold on to them patiently. Very few fund managers have the reputation of providing higher reruns in the small-cap space.
- The investment mode:
Timing the markets is not the right approach for investing in mutual funds. Without the proper knowledge, you may lose all your money while speculating and timing the market. Therefore, experts recommend investing in mutual funds through SIP or systematic investment plan mode. It helps you avoid timing the market and averages your purchase cost over time. To ascertain your monthly investment amount, you can use a free online SIP calculator.
There are numerous other factors that you must check for investing in small-cap equity mutual funds. A small cap fund requires you to have a high-risk tolerance. Start your investment journey if your risk appetite is high.