Why Small Cap Mutual Funds in India Can Offer Big Returns – With High Risks

In India, small cap mutual funds have attracted large followings of investors with an objective of high growth prospects. Such funds invest in the companies with smaller market capitalization, usually those that are ranked 251st and above as mandated by SEBI. They promise to bring lucrative interest but have their own problems.

The Allure of High Returns

In the last couple of years, best small cap mutual funds in India have performed better than the large-cap funds. An example is the SBI Small Cap Fund, which registered a compound annual growth rate (CAGR) of 21.87 per cent in the last seven years and is amongst the best-performing equity mutual funds in this duration. On the same note, the Bandhan small cap fund has yet to produce an impressive 36.4 percent CAGR in previous five years.

Such high returns are mainly owed to the high growth factor of small cap businesses. These funds can invest in new areas and new businesses and thus get to enjoy the growth of the new asset at the initial stage which tends to be very significant in terms of capital growth.

Navigating the High-Risk Terrain

Even though the returns are appealing, small cap mutual funds are riskier in nature. Volatility of small cap stocks is much higher than that of the large-cap stocks. These funds have a tendency to fall more severely during downturns in the market. As an example, in the market crash of 2020, the Nifty Smallcap 100 index declined by 38 percent versus a 29 percent decline in the Nifty 50.

Furthermore, small cap firms usually lack resources, access to capital as well as may be unable to scale. This has the propensity of increasing business risks such as operating inefficiencies and susceptibility to economic cycles.

Choosing the Best Small Cap Mutual Funds

Before an investor decides to invest in small cap mutual funds, there are various factors to be put into consideration. The main measurements are the history of the fund, expense ratio, the scale of assets under management (AUM), and the experience of the fund manager. Some of the best funds in India are the Quant small cap fund, Nippon India small cap fund and HDFC small cap fund that have performed well.

It is also necessary to evaluate the portfolio diversification of the fund, sectoral distribution, and growth potential of the companies behind it. Individual stock volatility risks may be checked by having a good portfolio that is diversified. Mitigating Risks in Small Cap Investments

Although best mutual funds are associated with elevated risks, there are measures that investors can take in order to control the risks. The performance of the fund should be tracked down, the market trends should be kept in mind and then they should be prepared to weather the short-term variations. Also, it is possible to avoid the market fluctuations and take advantage of the growth potential of small cap companies by keeping a long-term investment horizon.

Conclusion

In India, small cap mutual funds provide an opportunity to investors to earn a high level of returns through the growth of the emerging firms. Nonetheless, there are more risks associated with these opportunities. It is possible to overcome the terrain of small cap investing that is heavily fraught with risk by choosing well-managed funds, diversifying investments, and taking a long-term outlook.