Why Are Small-cap Mutual Funds Gaining Momentum?

Small-cap mutual funds have been experiencing a surge in popularity among investors due to their potential for their high risk and return profile. These highly volatile funds primarily invest in emerging organisations that offer small-cap stocks, which tend to have better growth prospects than larger, established organisations. Consequently, investors are drawn to these funds in search of the potential for substantial returns.

Investors can buy these small-cap mutual funds online and manage them in affordable Demat accounts offered by platforms like Share India.

In this blog post, we will explore the basics of small-cap mutual funds and investigate the reasons for the uptrend in investments in small-cap funds.

Defining Small-cap Mutual Funds

Small-cap mutual funds invest in stocks offered by companies with a market capitalisation of less than ₹500 crores. These funds tend to have a high risk associated with them and are, therefore, suitable for investors who have a high-risk tolerance. Small-cap funds also offer high growth potential. These small-cap companies are relatively new in the stock market and have the potential to grow rapidly but also have the potential to fail. Therefore, it is crucial to assess one’s risk tolerance and investment goals to manage risk.

Feature of Small-cap Funds

• Predominant investment in small-cap stocks: Small-cap mutual funds predominantly invest in small-cap stocks, with a small portion of investments in mid to high-cap stocks to diversify the risk. 
• Volatile: Small-cap stocks are highly volatile. These tend to outperform large-cap funds during market highs and tend to underperform during a low market phase.
• Variable time horizon: Small-cap mutual funds are suitable for short-term investors as well as long-term investors. Since they have high growth prospects, they have the potential to offer high returns in the short term as well as in the long term.
• High-risk profile: Small-cap funds are predominantly known for their high-risk factor. These funds are susceptible to dynamic price fluctuations in the volatile market. Hence, they can be suitable for investors who are looking for risky investments.

Growth of Small-cap Funds in India

• Small-cap stocks started gaining momentum in the 2000s when mid-cap and small-cap stocks began to outperform large-cap stocks. In 2008, the prices of mid-cap and small-cap stocks sharply declined, influenced by the global financial crisis.
• These stocks started to recover and witnessed strong growth in the stock market.
• The year 2018 witnessed a reclassification of mutual fund schemes into small-cap and mid-cap funds based on the market capitalisation of stocks.

Reasons for Momentum Gained by Small-cap Funds

Diversification of Portfolios

Small-cap mutual funds present a suitable opportunity for investors to expand their investment portfolio and gradually augment their risk appetite. These funds invest in a diverse range of companies across various sectors, thereby aiding investors in diversifying their overall risk profile.

High Growth Potential

Small-cap companies are young companies operating in niche sectors or adopting innovative business models. Therefore, these companies have room for growth, which translates into higher return opportunities for investors. This explains why small-cap funds are suitable for investors with a high-risk appetite. 

Outperformance in the Stock Market 

The stock market has witnessed various incidents where small-cap funds hit high records, often outperforming large-cap funds. This remarkable growth has been influenced by factors such as favourable economic conditions and regulatory reforms. This outperformance has allured both domestic and international investors to gain opportunities in this vibrant sector of mutual funds. 

Economic Growth

Small-cap funds allure domestic and international investors to the Indian stock markets. This inflow of capital from domestic and international sources boosts the financial markets and economy in its entirety. Apart from capital inflow, these small-cap companies are expected to drive significant growth in the economy, creating favourable economic conditions.

Conclusion

In the momentum-laden market environment, as small-cap funds outpace new benchmarks, investors must analyse the factors leading to such growth. Small-cap funds also tend to underperform in various circumstances as the market low hits. With adequate research, analysis of market risk and diversification, investors can use small-cap funds to their advantage.

Investors can use platforms like Share India to buy mutual funds online and handle their mutual fund investments at one destination. With Share India’s free Demat account with zero opening fees, investors can take control of their portfolio at one secure platform and access their investments on the go.