What is Small-cap Mutual Funds? - Overview, meaning & features

Small-cap mutual funds have emerged as a prominent investment option in recent years, witnessing an impressive 42% annualised growth over the past five years in its assets under management, totaling Rs 2.7 trillion as of May 2024 (Source: AMFI). This remarkable performance makes Small-cap Mutual Funds the fastest-growing category, attracting investors seeking high returns.

Understanding Small-cap Mutual Funds

Small-cap mutual funds focus on investing in companies with smaller market capitalisations, typically those ranked below the top 250 listed companies. Small-cap funds invest atleast 65% of its assets in small-cap companies.

Owing to their smaller size, small-cap stocks present significant growth potential but also come with higher risk compared to large-cap and mid-cap stocks.

Investing in Small-Cap Mutual Funds allows for diversification within your portfolio, providing opportunities to benefit from the rapid growth of emerging companies poised to become future industry leaders.

How does a Small-cap mutual fund work?

A Small-cap mutual fund pools money from multiple investors to invest in a diversified portfolio of Small-cap stocks. These funds invest a minimum of 65% in small cap stocks.

Professional fund managers conduct thorough research and analysis to identify high-potential companies, aiming for long-term capital appreciation. These managers actively buy and sell stocks to optimise returns while managing risk. The fund's performance depends on the underlying stocks' success and the manager's ability to navigate market fluctuations.

Investors purchase units of the fund, gaining exposure to a broad array of small-cap companies, and the fund's value increases or decreases based on the collective performance of its holdings.

Features of Small-cap Mutual Funds

• High growth potential: Small-cap stocks offer rapid growth potential owing to their smaller size, allowing room for expansion into new markets. These companies are in early business stages and actively pursue growth opportunities. They offer significant returns through expansion strategies and market share increase. Investing in Small-cap mutual funds enables you to capitalise on the high growth trajectory of these dynamic companies.
• Investment horizon: Small-cap mutual funds are suitable for investors with a long-term horizon. These funds focus on small-cap stocks with significant growth potential from aggressive expansion strategies. Staying invested longer enhances the chances of substantial capital returns. Given volatility, a long-term approach helps navigate market fluctuations and capitalise on company growth over time.
• Risk tolerance: Investors in Small-cap mutual funds need to have high risk tolerance, as these funds are highly susceptible to market volatility. While small-cap stocks offer significant returns owing to their high growth prospects, they also lack the financial strength and organisational stability of large-cap stocks. Consequently, Small-cap Funds can be extremely volatile and are not suitable for risk-averse investors.
• Potential for alpha generation: Small-cap mutual funds have the potential to generate alpha, meaning they can outperform the market benchmark. The fund manager's ability to identify undervalued stocks can lead to superior returns for investors.
• Diversification: Small-cap mutual funds offer diversification benefits by spreading investments across various small-cap stocks. This diversification helps mitigate individual stock risk and can enhance overall portfolio stability.
• Liquidity concerns: Small-cap stocks may face liquidity concerns as they are not as widely traded as Large-cap stocks. This can pose challenges when trying to sell holdings quickly, potentially impacting investment decisions. The lower liquidity and fewer market participants make small cap stocks harder to trade, affecting your ability to exit positions efficiently.
• Overlooked by institutional investors: Small-cap stocks are often overlooked by institutional investors due to their lower market capitalisation. This provides an opportunity for retail investors to capitalise on the growth potential of these undervalued companies.

Also Read: How to invest in Mutual Funds in 7 easy ways

Conclusion

Small-cap mutual funds offer a unique opportunity to invest in high-growth potential companies, making them an attractive option for investors willing to take on higher risk for potentially higher returns. By understanding their features, benefits and investment strategies, you can make informed decisions to enhance your investment portfolio.

Axis Bank allows you to invest in different types of mutual fund schemes. Check Axis Bank's offerings online to compare and choose small-cap funds of your choice.

Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.
Mutual Fund investments are subject to market risk, read all scheme related documents carefully. Axis Bank Ltd is acting as an AMFI registered MF Distributor (ARN code: ARN-0019). Purchase of Mutual Funds by Axis Bank’s customer is purely voluntary and not linked to availment of any other facility from the Bank. T&C apply.