Small cap mutual funds invest at least 65% of their total assets in small-cap companies. Small-Cap companies are emerging businesses that have an aggressive expansion strategy being more volatile and vulnerable to market movements.
Mutual funds are categorised based on their investment style. Equity mutual funds invest a major part of their corpus in equity and equity-related instruments. The regulatory authority Securities and Exchange Board of India (SEBI) has standardised mutual funds based on their categories and characteristics of each category.
Small Cap mutual funds are equity mutual funds. Smallcap funds asset allocation is such that they invest at least 65% of their total assets in small cap companies. Small Cap companies are those companies that rank above 250th in terms of full market capitalization. In other words, these are companies with a market capitalization less than INR 500 crores.
Small cap mutual funds are open-ended equity schemes that invest primarily in small cap stocks. These funds portfolio asset allocation has a minimum investment of 65% of total assets in equity & equity related instruments of small cap companies. Small Cap companies are emerging businesses that have an aggressive expansion strategy. These stocks are more volatile and vulnerable to market movements. As a result, smallcap funds are comparatively riskier than large cap, mid cap or multi cap mutual funds.
Small cap mutual funds have the potential to earn benchmark beating returns
As small cap mutual funds are high risk investment options, they suit investors who are willing to undertake such a risk. The risk taken is supposed to be compensated with significant returns. In the long term, small cap mutual funds have the potential to earn benchmark beating returns. For an investment horizon of 7-10 years and above, returns from top funds can be around 12-15%.
Most importantly while investing in small cap mutual funds, investors should be patient. Regular investments in smallcap funds help in averaging out the risk and market fluctuations. Therefore, investing through the SIP route will be beneficial in the long term. Additionally, investors shouldn’t resort to panic selling, investing through an entire business cycle is always beneficial. Hence Small cap funds have a good potential to earn significant return over a period of time. However, past performances are just an indication of the funds performance since inception. Investors shouldn’t highly depend on past performances.
Features of Small Cap Mutual Funds
Best small cap mutual funds provide an opportunity for investors to earn returns from growing companies. However, small cap companies are subject to market risk. Investors should understand how the funds work and weigh their pros and cons before investing in them. Here are the features of small cap mutual funds.
High Returns: The best small cap mutual funds have a potential to earn significant market beating returns. Since small cap mutual funds majorly invest in small cap stocks, they tend to have similar pros and cons of small cap stocks. Small cap stocks are often included in the list of high yielding stocks in a bull run. Often these stocks appear in the list of multi-baggers. However, in bear phase the returns might be highly affected and may give negative returns. One can always use Scripbox’s SIP calculator to find out the potential SIP returns from a small cap mutual fund.
High Risk for High Returns: Small cap mutual funds are risker than large and mid cap funds. This is mainly because unlike small caps, large and midcap companies can handle adverse situations better. Large cap companies are established businesses and hence any negative market sentiments affect them lesser than smaller companies. Whereas, small cap companies are emerging business firms and are in the process of becoming mid and large cap companies. Even a slight market correction can affect these companies adversely.
Investment Horizon: Best small cap mutual funds are synonymous with long term. Any investments made in these funds have to be held for a minimum investment horizon of 7 years. There is no hard and fast rule to it. However, long term investment will help to spread the risks associated with them and also help in generating substantial returns.
Volatile: Small cap mutual funds are extremely sensitive to market conditions and hence are very volatile. Small cap stocks react very fast to market movements. Few factors that affect these stocks are investor sentiment, economic factors, corporate actions, etc. This volatility can lead to significant market beating returns or can affect the smallcap mutual fund returns negatively.
Invest in small cap companies: Small cap mutual funds portfolio invests in small cap companies. These include companies with lower revenues and sometimes emerging business firms that are in their early stages of development. Since the companies are relatively new, they have a very high growth potential than large and mid cap funds.
Benefits of Investing in Top SmallCap Funds
High growth potential: Small cap mutual funds invest in small cap companies that have a high potential to grow. They are comparatively new and small than large and midcaps. They are in the early stages of their life cycle, leaving them a huge opportunity to grow.
Adaptability to market conditions: Small cap stocks can be highly adaptable to market conditions. Their small size helps them in adapting to any changes in the market. This helps in protecting the support levels of the stocks in adverse situations.
Fairly priced: Best small cap funds invest in small cap stocks that are underfollowed in the market. Hence good quality stocks that are fairly priced are included in the portfolio by small cap fund managers. This increases the chance of earning significant market beating returns.
Diversification: Top smallcap funds increase diversification in a portfolio. Investors investing in large cap and midcaps can invest in small caps to broaden their portfolio and diversify their sector allocation. During market highs, small cap funds have the capacity to give better returns than large and midcap funds. Hence having these in a portfolio, will not only provide diversification but boost the portfolio returns as well.
Returns: Top small cap mutual funds have the capacity to give significant market-beatingmarket beating returns if invested in the right stocks at right time. Fund managers of small cap funds perform extensive research to pick high yielding stocks for the portfolio to maximize returns. Also, in a bull run, their returns can be higher than pure large cap or even multi cap funds.
SIP and long term investing: Investing in smallcap funds can be done through SIP and lump sum route. While, both ways of investing can yield good returns, SIP investment can boost returns further. Investors need not worry about the timing of investment, when they invest they do a SIP investment. This is because they invest regularly in these funds for a long term covering all market cycles. This manages the risk of investing in small caps better and also averages out the cost of investing. And also boosts returns through power of compounding. Hence helps in achieving financial goals.
Taxability of Small Cap Mutual Funds
Mutual funds have two types of taxes – Capital Gains Tax and Dividend Distribution Tax (DDT). They are taxed based on the investment term. The Capital Gains tax is determined based on the holding period of the investment. Therefore, taxation of Equity mutual funds and debt mutual funds is quite different. Among equity funds, only ELSS mutual funds (Equity Linked Savings Scheme) qualify for tax savings.
Small cap equity mutual funds predominantly invest 65% in small cap stocks. Therefore, they are taxed as equity funds.
Capital Gains Tax:
Short Term Capital Gains Tax (STCG): Investments held for less than one year, the capital gains are taxed at 15% p.a. (plus 4% CESS).
Long Term Capital Gains Tax (LTCG): For a holding period beyond one year, the gains are taxed at 10% p.a (plus 4% CESS). The gains up to INR 1 Lakh do not attract LTCG.
Dividend Distribution Tax: From April 1st 2020, dividends are taxed in the hands of investor. Dividends earned are added to the taxable income and are taxed according to the income tax slab rate. For dividends above INR 5,000 a 10% TDS is cut. Additionally, equity mutual funds are subject to securities transaction tax is 0.001% if investors sell their holdings. One can use Scripbox Income Tax Calculator to calculate their income tax outflow and their income tax savings.
Small cap mutual funds provide an excellent opportunity to boost returns and diversify risk in a portfolio. Even though they provide good returns in a Bull Run, they are considered most risky among other mutual funds. In adverse market conditions, their returns might be affected negatively. Hence investor should understand that small cap equity funds alone cannot help in earning good returns. Investors can focus on reducing the risk on investing in small cap funds by taking some measures.
There are other alternative investment opportunities like large cap equity funds (bluechip fund), mid cap equity funds, multi cap equity funds and hybrid funds that also have the potential to earn good returns with moderate risk. For minimum risk and predictable return investors can look at debt fund. Investors can look at investing in these to broaden their portfolio. Also, one can use Scripbox’s online SIP calculator to calculate the potential SIP returns from their investments.
Buying or selling investments in smallcap funds in a hurry should be avoided. Both, short term gains and losses are temporary. Hence investors shouldn’t be in a hurry and should instead invest for the long term (minimum 7 years). Invest in best small cap equity funds through SIP. This will average out the cost of investing and help manage volatility.
Whether small cap or not, investors should always invest in top funds that match their financial goals and their financial standing. They can always seek professional advice to invest in mutual funds. Scripbox curates portfolios with top funds using their proprietary algorithm. Investing can be risky, but not investing in mutual funds might lead to missing out on opportunities to earn good returns. Happy investing!
Frequently Asked Questions
Does Smallcap mutual funds qualify for tax savings?
Small cap funds do not qualify for tax savings. ELSS mutual funds are the only type of mutual funds that qualify for tax savings under Section 80C of the Income Tax Act. However, there are other investments options like Fixed Deposit, Public Provident Fund, Employee Provident Fund, Senior Citizen Saving Scheme, NPS etc. All these are investment options that help one save tax. Hence instead of keeping the money idle in a saving account, investors can invest in any of the above options. During tax filing, the investors can show the investments done in above options under section 80C of the Income Tax Act. Therefore, the total taxable income comes down during tax filing.
How to invest in small cap equity funds?
One can invest in small cap equity funds through online and offline mode. Investors can visit the fund house’s office directly and fill in the paperwork to invest in the fund through offline mode. They can also approach brokers or distributors who will file the paperwork for the investors. One has to submit the following documents to the fund house 1. Identity Proof – Aadhar card 2. Cancelled Cheque 3. Passport size photographs 4. Pan Card 5. KYC Document (for KYC verification) Investors can visit multiple online portals like Scripbox to invest in equity funds. They collect aadhar card, pan card and other proofs directly online with zero paperwork. These online portals also offer customized services. The portal provides funds that best suit investors’ objectives, risk appetite, and investment horizon.
How to select a smallcap mutual fund to invest?
Selecting a smallcap mutual fund to invest requires time and knowledge to scrutinize the funds in detail. Investors have to consider qualitative and quantitative factors for shortlisting small cap mutual funds. The quantitative factors such as past performances (returns), Sharpe ratio, standard deviation, and treynor ratio. And qualitative factors such as financial goals, AUM, and fund manager’s experience. Sharpe ratio and standard deviation help understand an investor better about the risk in the fund.