With valuations in the small cap space now down significantly, many wealth advisors believe investors could go for a staggered investment in this space.
What are small cap funds?
Small cap equity funds are those which invest in shares of companies which have smaller market capitalisation and invest in the 251st company onwards in terms of full market capitalisation. In such a fund, the fund manager needs to have a minimum exposure of 65 per cent to such companies. The balance 35 per cent can be in mid-, large- or small-cap companies depending on the view the fund manager has on the market.
Why are small cap funds popular amongst investors?
Many wealth managers believe the small cap space is where a fund manager will be able to generate higher alpha in the years to come. This is post the Sebi norms on categorization of mutual funds. While only 100 stocks are available in the large cap space, 150 stocks are available in mid cap and over 2,000 in small cap. As many as 30-40 analysts cover a large cap stock, in the BSE Small Cap index there is a dearth of analyst coverage. Many stocks are not covered by analysts, leaving a lot of scope for fund managers to generate alpha. Since the small cap universe is large, fund managers may incrementally look forward to invest in this space.
Are small cap funds meant for every investor?
Small cap funds carry higher market risk when compared to other categories like large- or mid-cap funds. Investors with the ability to digest higher risk and with a longer time frame of 7-10 years could look at investing here. Wealth managers suggest investors must have a small portion of his/her portfolio allocated to small-cap funds. One of the best ways of investing in this segment of the market to reduce risk could be using systematic investment plans (SIP) as that would stagger your investments over a period of time. Small-cap equity funds can be ideal for investors who may have long-term goals like planning for children’s education, saving for retirement, Historically, these funds have delivered higher returns as compared to the benchmark.
Many small cap funds allow only SIPs and do not permit lumpsums…
All small-cap funds do not permit lumpsum investment. Depending on the fund manager’s view on the market and the assets he can manage. Once the fund reaches a particular size, the fund manager may close it temporarily for high-ticket lumpsum investments and allow only SIPs.