In the past few years, small-cap funds have amassed a great deal of popularity in the investment space. With over 100% returns in the last year itself, it’s no wonder that they’ve caught investors’ attention. Being the most volatile out of all equity funds, small-cap funds can deliver massive returns. However, on the flip side, these funds have to wade through tricky market waters as well.

So, with your portfolio already featuring large caps, multi-caps, and mid-caps, should you bother with small caps at all? Are they lucrative enough? Well, let’s tackle all these questions and more. But before that, here’s a quick refresher on small-cap funds.

What are small-cap funds?

Small-cap funds are open-ended equity funds that, for the most part, invest in small-cap stocks. As per SEBI, small-cap funds must invest a minimum of 65% of their assets in small-cap companies. Plus, these companies usually rank beyond 250 when it comes to market capitalisation.

Performance

Since small-cap companies are in their nascent growth stages, they have a long way to go before generating any consistent growth.

With that said, small-cap companies perform explicitly well in a bullish market. However, a little nudge in the downward direction and their volatility gets more pronounced. Therefore, you, as an investor, must practice caution while investing in small-cap mutual funds.

Long-term investors have benefitted significantly by taking high-risk small-cap funds. In the last five years, small-cap funds have delivered a growth rate of 17.7%, which is better than large (14.1%), mid (16.0%), and multi-caps (11.6%). However, small caps have lagged behind other categories in the short term, given their high volatility.

For instance, after a rollicking 2017, when NiftySmall50 delivered 59% in returns, it fell into the negative for the next two years, only to rally again in 2020.

Additional Read: How to Manage Your Mutual Funds Smartly/Wisely

Who should invest in small-cap funds?

Given their volatility, it’s best to invest in small-cap funds if you can stomach the higher risks. One way to mitigate volatility is to invest less. Commit no more than 5-8% of your portfolio to small caps. That way, you can rejoice at the returns and not feel too cheated if your investment underperforms.

Also, you must be ready to cool your heels for the long haul (7-10 years) to weather out their volatility.

Is now the right time?

Talking about the future, in the coming years, government policies like production-linked incentives and increased focus on infrastructure will ensure broad-based economic growth. These developments should help small-cap companies achieve good profit growth.

Also, with the rising stock prices and incremental investments by investors, 2021 is a great year to invest in small-cap funds.

Additional Read: Multi-Cap or Flexi Cap which Fund is better suited for you?

Final takeaway

Small-cap funds are undoubtedly a fantastic asset class to diversify your portfolio and get robust returns. However, you need to approach the investment, keeping into account your risk profile and time horizon. If you’re risk-averse, it’s best to go for the long haul. If you can read the market like a book, a shorter term will suit you well.

Also, since small caps are now in a post-pandemic rally, your mindset going into the investment matters. Don’t invest if you wish to play the momentum or if you’ve riddled with FOMO.

Start investing in small caps today with Tata Capital’s Moneyfy app and multiply your savings with lucrative MF schemes. Choose an investment instrument as per your objectives and start reaping returns today!

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