Most of the big companies on the market today started out modestly. The company only became successful after a certain period. Their performance fluctuated initially because they were small and had limited resources. This type of startup company is known as a small-cap company, and investing in such companies can be done through small-cap mutual funds. Small cap fund is discussed in this article, along with their benefits and features.
What is a Small Cap Fund?
Small cap funds invest primarily in equity or equity-related instruments of small-cap companies. According to the Securities and Exchange Board of India (SEBI), small-cap funds need to invest at least 65% of their total assets in small-cap companies. In addition, SEBI defines small-cap companies that are ranked below the 250th rank in terms of market capitalisation on the exchange. The market capitalisation of these companies is less than Rs. 5000 crores.
It is important to note that these funds carry a significant level of risk. Even the slightest market volatility can have a major impact on the share prices of small-cap companies. However, these stocks may also have the potential to offer higher gains. If a small company has a scope for growth and if it does grow then the share price will increase dramatically.
Investors usually turn to small-cap mutual funds for short-term investment needs. However, this can be counterproductive as these companies need time to grow. Therefore, investors having high-risk tolerance and a long investment horizon should consider investing in this fund.
Features of Small Cap Fund
Now that you understand what small cap funds are, let’s examine the features of these funds. The major features of small-cap funds are:
- Long-term Investment: Small-cap stocks are sensitive to market movements. Therefore, these stocks may be negatively affected when the market slumps. Because of this, investing in this fund requires a long-term horizon so that returns can be generated over the long run. As a result, these funds are suitable for long-term investors with the recommended time frame of 8-10 years.
- High Risk: There is a potential for small-cap funds to earn returns that beat the benchmark. These are high-risk investments that should only be considered if you can handle the price volatility. To boost your wealth, you can allocate a portion of your portfolio to small-cap stocks and stay invested for a long time.
Benefits of Investing in Small Cap Fund
Long-term investors may benefit significantly from these funds if they remain invested for a long time. The benefits of investing in small cap funds are:
- Potential for High Growth: In small-cap funds, investments are made in start-ups or emerging organisations with room for expansion and diversification. Hence, these funds have a high growth potential.
- Diversification Opportunity: Investing in small-cap mutual funds can diversify your financial portfolio. By doing so, you reduce your overall investment risk and increase your chances of being protected during market downturns.
- Undervalued Opportunities: The big institutional investors often ignore small-cap stocks, leaving room for organic growth. Small-cap stocks can be undervalued in the market since analysts and institutions pay less attention to them, allowing fund managers to take advantage of undervalued opportunities.
- Possibility of M&A (Mergers and Acquisitions): There is a high possibility of M&A for small businesses. To grow, they can either be acquired or merged with a larger counterpart. Thus, small businesses’ stock prices can rise, which can eventually increase the value of small-cap mutual funds.
Who Should Invest in Small Cap Fund?
Certain investors can benefit from small caps based on their risk profile, goals, and investment horizon. The following types of investors are suitable for small-cap funds.
- Long-Term Investors: Investing in small-cap stocks can be volatile in the short term, so they are suited to long-term investors. Small-cap funds have the potential to generate significant returns over the long term.
- Risk Tolerance: Small-cap stocks tend to be more volatile than large-cap stocks. Small-cap funds are suitable for investors who are willing to take risks and take advantage of market fluctuations.
- Diversification Seeker: You can diversify your portfolio by adding small-cap funds. In various sectors, it invests in new and emerging businesses in their early stages of business. In this way, the fund can minimise portfolio risk and maximise returns. To explore multiple market segments, you may consider small-cap funds as part of your portfolio.
- High Growth Seeker: A small-cap stock has the potential to grow since it invests in early-stage companies. Hence, small-cap funds are a suitable choice if you want high growth but accept higher volatility.
Conclusion
Investing in small-cap funds allows investors to take advantage of emerging companies’ growth potential while diversifying their portfolios. The investment of small-cap funds requires a long-term horizon and a high tolerance for risk. Hence, long-term investors looking for high growth and willing to withstand market fluctuations may consider these funds. The investment goals, risk tolerance, and time horizon of investors can help them determine whether funds meet their financial objectives. Moreover, if you’re interested in investing in tax-saving funds, you can use the ELSS app. ELSS is a tax-efficient investment option that combines the benefits of wealth creation and tax savings.
Note: Views and opinions contained herein are for information purposes only and should not be construed as investment advice/ recommendation to any party or solicitation to buy, sale or hold any security or to adopt any investment strategy. It does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The recipient should exercise due caution and/ or seek professional advice before making any decision or entering into any financial obligation based on information, statement or opinion which is expressed herein.
Past performance may or may not be sustained in future.
Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.
ELSS Investments are subject to a 3-year lock in period and are eligible for Tax Benefit under section 80c of Income Tax Act, 1961.
“As per the present tax laws, eligible investors (individual/HUF) are entitled to deduction from their gross income of the amount invested in Equity Linked Saving Scheme (ELSS) up to Rs.1.5 lakhs (along with other prescribed investments) under section 80C of the Income Tax Act, 1961. Tax savings of Rs. 46,800 mentioned above is calculated for the highest income tax slab.
Finance Act, 2020 has announced a new tax regime giving taxpayers an option to pay taxes at a concessional rate (new slab rates) from FY 2020-21 onwards. Any individual/ HUF opting to be taxed under the new tax regime from FY 2020-21 onwards will have to give up certain exemptions and deductions. Since, individuals/ HUF opting for the new tax regime are not eligible for Chapter VI-A deductions, the investment in ELSS Funds cannot be claimed as deduction from the total income.
Investors are advised to consult his/her own Tax Consultant concerning the specific amount of tax and other implications arising out of his/her participation in ELSS”
Market caps are defined as per SEBI regulations as below: a. Large Cap: 1st -100th company in terms of full market capitalization. b. Mid Cap: 101st -250th company in terms of full market capitalization. c. Small Cap: 251st company onwards in terms of full market capitalization.
