Small Cap Funds

Small cap mutual funds are those equity funds that mostly invest in companies that are not in the top 250 list. It may include stocks from the 251st onwards, and the list goes beyond.

Typically, these companies are still in their early growth stages and have market capitalisation (which is subject to change every 6 months by AMFI - Association of Mutual Funds in India). Hence, they have a greater scope to appreciate and deliver better capital gains. But it equally comes with more risk and volatility.

In par with all mutual fund schemes, even small cap mutual funds follow the same distribution strategy. Here, at least 65% of these funds' assets go to stocks and other equity-related securities of small-cap enterprises. And the rest (up to 35%) is distributed among mid-cap, large-cap stocks, debt, and liquid instruments. However, this allocation (balance) can vary from fund to fund.

Likewise, fund managers carefully research and choose firms that have a good chance of growing at a quick pace. Also, they keep in mind those companies that have the potential to do better in the future.

Small cap funds are designed for investors who are ready to take a little more risk — and stay invested for the long run.

You should consider investing in small cap funds if you:

• Have a long-term investment horizon (five years or more) - These funds need time to grow and recover from market ups and downs.
• Those who can handle volatility - Small cap stocks can fluctuate sharply in the short term, but historically reward patient investors with value appreciation over time.
• Already have a diversified portfolio and want to explore beyond large and mid-cap allocations.

Looking to invest in Small Cap Mutual Funds online?

Here’s how you can invest in these funds with Anand Rathi in just 4 easy steps.

Before investing in small cap mutual funds, consider the following points:

• Investment Horizon: While these companies are in the growing stage, investing with a short-term mindset doesn't work. It takes time for an investment to nurture and mature.
• Risk Appetite: Small cap funds are more volatile than large or mid cap funds. Hence, it is always a crucial point to align your risk tolerance with the fund you choose.
• Fund Performance: Unlike other funds, they are more prone to market cycles. Thus, reviewing the fund's historical performance across different periods can help in understanding the future outlook.
• Expense Ratio: The fee of managing the fund can determine how your net yields are reduced over time. And that's what a high expense ratio does.
• Fund Manager's Experience: Experienced fund managers can typically use their exposure to navigate market fluctuations more effectively.

Taxation for small cap mutual funds in India is as follows:

• Short-Term Capital Gains (STCG): If units are sold within 12 months, gains are taxed at 20%.
• Long-Term Capital Gains (LTCG): For units held longer than 12 months, gains up to ₹1.25 lakh are tax-exempt. Gains exceeding ₹1.25 lakh are taxed at 12.5%.