Equity mutual funds are one of the most popular investment options for growing wealth. Many investors tend to stick to large-cap mutual funds as these funds tend to offer stable returns and are low-risk. However, investors looking to grow their wealth and who are not afraid of risk choose small-cap funds such as the one offered by the Canara Robeco Mutual Fund house.
What are small-cap mutual funds?
Equity mutual funds can be categorised according to the size of the companies they choose to invest in, so there are large-cap, mid-cap, and small-cap funds. According to the Securities and Exchange Board of India (SEBI), small-cap funds invest a minimum of 80% of their corpus in small-cap companies. Small-cap companies are those that rank below 250 in terms of market capitalisation. These companies usually have a market capitalisation below Rs 500 crore. These are young companies in the phase of aggressive growth and expansion.
What are the features of small-cap mutual funds?
- They invest a bulk of their corpus in small-cap stocks, with the remaining corpus may be invested in mid to large-cap stocks.
- As they invest in up-and-coming companies, they carry more risk and volatility compared to other funds.
- However, because they invest in growing companies, the potential for fruitful returns is very high. These funds, such as the Canara Robeco Small Cap Fund (direct growth), often outperform the small-cap benchmarks. They tend to give excellent wealth-creating returns when the market is doing well.
- The companies they invest in are usually focused businesses that have a single line of business with little to no diversification.
- Since the companies they invest in are in the phase of growth, these funds often outperform large-cap funds over a long period.
What to keep in mind when investing in small-cap mutual funds?
- Small-cap funds are more volatile compared to mid-cap and large-cap funds. When the market is not performing well, they may suffer as they are not as established as larger companies. However, for investors who can tolerate risk, this is an ideal investment as it can bring superb returns when markets are doing well.
- According to the Association of Mutual Funds in India (AMFI), most small-cap funds have performed exceptionally well in the last few years. Small-cap funds have the potential to be a multi-bagger (can give returns of over 100%) over time.
- Small-cap funds often have high expense ratios. SEBI has marked the upper limit of the expense ratio for these funds at 2.25%. So, investors should look to lower their costs as much as possible when investing in these funds. One way to do this is by choosing the direct investment option, for example, the Canara Robeco Small Cap Fund (direct growth) scheme. The direct scheme gets rid of the intermediaries, so the Canara Robeco Mutual Fund house does not have to pay distribution expenses. Hence, the resulting costs are lower, which is better for the investor.
- Small-cap funds may give poor returns when the market is on a downswing. For this reason, investors should keep a longer investment horizon of 7 to 10 years when investing in these funds.
- As these funds can be volatile, it is preferable to invest in them via a systematic investment plan (SIP) rather than making a lump sum investment. Rupee cost averaging helps reduce the cost of holding and works to the benefit of the investor.
- Small-cap mutual funds are subject to long-term and short-term capital gains tax when the investor redeem units of these funds. STCG or short-term capital gains would have short-term taxes at 15% for units held for a year or less. LTCG or Long-term capital gains on units held for over a year are taxed at a flat rate of 10% without any indexation benefits.
- Take a closer look at the past performance of the fund for the past four to five years. For example, the Canara Robeco Small Cap Fund (direct growth) scheme by the Canara Robeco Mutual Fund house gave a return of about 30% per annum since its inception in 2019. Unlike large-cap funds, small-cap funds are heterogeneous. So, if a small-cap fund shows consistent performance over four to five years, it is strongly indicative of the fund’s future performance.
Why should you invest in small-cap mutual funds?
- Great growth potential as small-cap companies can generate better returns than bigger companies.
- Diversify your investment portfolio, especially if the rest of your portfolio has low-risk and low-return investment vehicles.
- You have a go big or go home attitude toward investing.
- You are ready to ride out short-term losses as these funds offer healthy returns in the long term.
Small-cap funds are volatile. Hence, they are suited for aggressive investors with a large risk appetite who can tolerate high risk in pursuit of even higher returns. Investors should choose their investments carefully based on their investment horizon and goals.