Many of the companies under small-cap funds usually go through difficult phases when markets are not doing well and generally they take more time to revive or fail to revive as well. Hence, they are meant for investors who have a high-risk appetite.
Small-cap funds, a class of equity funds, invest mainly in the stocks of companies with a market capitalisation of less than Rs 5,000 crore. These funds invest in companies that have high growth potential and focus on newer business models.
Small-cap stocks and funds are the riskiest when you look at investing in equities from a market capitalization perspective. Hence, experts say they are suitable for those willing to take high risks and are well informed about the market to know when to exit.
Harshad Chetanwala, Co-founder, MyWeathGrowth, says, “These companies are at nascent stage and have a long way to go to deliver consistent growth from their businesses. There are more than 4,000 companies after the top 250 companies which are classified as small-cap.”
Small-cap funds have periods of massive gains and falls. Therefore, experts say they might not be right for investors who follow the invest and hold strategy. Small-cap funds are known to perform well in a bull-run market. They also steeply crash when the markets fall.
Who should invest in Small-cap funds?
Even though small-cap stocks are thriving, investing in small-cap funds can be a high-risk idea. While allocating funds, experts say, one could consider allocating a small portion of his/her portfolio towards small-cap funds due to their volatility.
Chetanwala says, “Many of these companies may go through difficult phases when markets are not doing well and they may take more time to revive or fail to revive as well. Hence, they are meant for investors who have a high-risk appetite.”
However, note that risks arise from not knowing what one is doing. Richa Aggarwal, Senior Research Analyst – Equitymaster, says, “Most small-caps are up in the post-pandemic rally, and a lot are priced to perfection already. The decision to invest in small caps at this stage should not be driven by playing momentum or by fear of missing out.”
She further adds, “The ideal way to look at it is which small-cap stock one would be comfortable holding even if the cycle turns. And there are quite a few with robust business models and strong management that one can consider for the long term.”
As an asset class, experts say all investors should consider small caps – What could vary is the allocation, depending on one’s risk profile and time horizon.
Chetanwala further adds, “At the same time, note that the allocation towards these funds and companies should not be more than 5-10 per cent of one’s overall portfolio.”