Small cap funds are open-ended equity funds that invest primarily in equity and equity-related instruments of small cap companies. Such companies include organisations that have a market capitalisation of not more than Rs. 500 crore. According to SEBI, small cap funds must invest at least 65% of their total assets in small-cap stocks. 

Since small cap companies are relatively small in terms of size, they also have a lot of potential to grow and provide more returns than large and mid-cap funds. However, small cap mutual funds are usually more volatile and susceptible to losses in bearish markets.

Best Small Cap Mutual Funds to Invest in 2021 

The following table lists the top 10 small cap mutual funds you can consider investing in:

Name of the Small Cap FundFeatures
Axis Small Cap Fund Direct-GrowthNet Asset Value (NAV) as of October 20 2021: Rs. 67.64
5-year annualised returns: 21.81%
Expense ratio: 0.37% per annum
Assets under Management (AUM) as of October 20 2021: Rs. 7095.11 crore
SBI Small Cap Fund- Direct Plan-GrowthNAV as of October 20 2021: Rs. 116.2545
5-year annualised returns: 21.89%
Expense ratio: 1.63% pa
AUM as of October 20 2021: Rs. 9711.37 crore
Kotak Small Cap FundNAV as of October 20 2021: Rs. 188.692
5-year annualised returns: 22.72%
Expense ratio: 0.47% pa
AUM as of October 20 2021: Rs. 5969.44
Sundaram Small Cap FundNAV as of October 20 2021: Rs. 163.1416
5-year annualised returns: 13.3%
Expense ratio: 2.19% pa
AUM as of October 20 2021: Rs. 1555.2 crore
Union Small Cap Fund- Direct GrowthNAV as of October 20 2021: Rs. 31.30
5-year annualised returns: 17.94%
Expense ratio: 1.85% pa
Assets under Management (AUM) as of October 20 2021: Rs. 563.54 crore
IDBI Small Cap Fund- Direct GrowthNAV as of October 20 2021: Rs. 17.42
3-year annualised returns: 20.84%
Expense ratio: 1.54%
AUM as of October 20 2021: Rs. 130.37 crore
Nippon India Small Cap FundNAV as of October 20 2021: Rs. 85.4057
5-year annualised returns: 22.23%
Expense ratio: 0.86%
AUM as of October 20 2021: Rs. 17282 crore
ICICI Prudential Small Cap Fund Direct Plan- GrowthNAV as of October 20 2021: Rs. 55.93
5-year annualised returns: 18.96%
Expense ratio: 0.64% pa
AUM as of October 20 2021: Rs. 3187.29 crore
Edelweiss Small Cap Fund- Direct GrowthNAV as of October 20 2021: Rs. 25.625
1-year annualised returns: 100.29%
Expense ratio: 0.58%
AUM as of October 20 2021: Rs. 1055 crore
Canara Robeco Small Cap Fund- Direct Plan- GrowthNAV as of October 20 2021: Rs. 24.36
1-year annualised returns: 106.62%
Expense ratio: 0.47%
AUM as of October 20 2021: Rs. 1621.6 crore

However, small-cap funds carry a certain degree of risk. So, if you are new to investing, you can start investing in large cap or Navi Nifty 50 Index funds. The Nifty 50 index fund tracks the market index of the top 50 companies to fetch you returns on your investments. You can start investing with Rs. 500, enjoy the lowest expense ratio and expect better returns in the long run.

Also Read: 10 Best Performing Index Funds That Can Be A Part of Your Portfolio

Who Can Invest In Small Cap Funds?

Investors with a high-risk appetite

Small-cap equity funds can be very risky investments, however, they can also provide the best returns. These stocks suffer the most during a sharp fall in the stock market and are subject to high volatility. As a result, only investors able to take high risks may consider these investments.

Those who are looking for large rewards

These mutual funds have the potential to offer superior returns over a long period compared to other types of equity funds. This is because companies with low market cap have a large potential to grow over time. Accordingly, there’s ample room for the company’s stock price to increase. 

Individuals seeking long-term growth

Sharp falls and prolonged periods of volatility are common for small-cap funds. As such, these are unsuitable for investors who have a low-risk appetite. However, patient investors who are willing to hold onto their investments for a long time (say 7 years or more) can get unmatched returns. 

Also Read: Investing In Mutual Funds: Benefits, Risks & Returns

How To Evaluate Small Cap Funds?

Consider the risk factor

Small cap funds have the potential to offer more than 100% returns in a day. However, there are risks associated with such funds. The Net Asset Value of a small-cap fund is hyper-responsive to the movements of its underlying benchmark. So, if the market conditions aren’t good, these funds can incur losses.

Long-term investment

Small-cap funds offer better returns in the long run. Hence, it’s good to have a long-term investment window, preferably 8-10 years, while investing in such funds.

Check expense ratio

Actively managed funds come with an expense ratio. It’s a fee that goes to the fund manager. Since, expense ratio takes a portion of your investments away, it’s advised that you go for a fund with a lower expense ratio. 

What Are the Pros and Cons of Investing in Small Cap Funds

Pros

  • Historically, these investments have delivered exponential growth and returns.
  • There is a high chance of finding undervalued stocks which perform well in a bullish market. 
  • A small cap company with the right plans and vision can suddenly rise up when no one is expecting it. This can positively impact its stock price, and subsequently, the performance of the fund that invests in shares of the company.
  • They can balance other investments in your portfolio by providing great returns. 
  • They are suitable for aggressive investors with a long term investment horizon. 

Cons

  • These funds might not be suitable for investors who may not have the patience to stay invested in a scheme for a long period.
  • As mentioned earlier, small-cap stocks carry high risk as they may not have adequate financial backing. In case a small cap company goes out of business, investors may suffer heavy losses.
  • With hundreds of small-cap companies, fund managers need to do thorough research to know which one has the potential to generate substantial returns. 
  • You have to time the buying and redeeming of these investments as market fluctuations can make or break them in a short time. That said, one can combat this issue by investing in small cap funds via a systematic investment plan (SIP). This investment route averages the purchase cost of the units over the long term. 

Also Read: Advantages And Disadvantages Of Mutual Funds

Some Factors to Consider before Investing in Small-Cap Funds

Risk vs returns

The NAV (Net Asset Value) of small-cap funds is highly sensitive to market sentiments. When the market conditions are unfavorable, small-cap funds can suffer a lot as they are not established businesses. However, they are an excellent option for patient and aggressive investors. 

Expense ratio

Fund houses charge a certain fee annually, known as the expense ratio, to manage the fund. The lower this amount, the higher returns you will get when you redeem your units. Hence, this is an important factor to look out for when shortlisting mutual funds.

Investment period

When the market becomes bearish, it can take a few years for the economy to recover. As small-cap stocks are highly sensitive to market conditions, it is better to have a long term investment horizon to have enough time to generate substantial returns. 

Diversification of portfolio

Small-cap funds invest in stocks across various sectors. This mitigates portfolio risk. You should make sure to compare the sectoral diversification of various small cap mutual funds before investing in any scheme. 

Experience of the fund manager

Fund managers of small cap funds buy and sell the underlying securities based on thorough research and specialized skills. Thus, the performance of a scheme directly depends on their competence. Hence, it is vital to consider the experience and track record of the fund manager before investing in small cap mutual funds. 

Final Word

Small-cap funds have the potential to generate higher returns. However, before investing, you should assess the risk involved. One of the ways to go about it is to diversify your investments in small- and large-cap funds. That way, you can have a balanced investment portfolio, which may help you to mitigate losses during market fluctuations. 

Frequently Asked Questions

Are there any taxes applicable for small-cap funds?

Depending on the holding period, short-term capital gains (STCG) tax of 15% or long-term capital gains (LTCG) tax of 10% is applicable on the realised returns. Nevertheless, note that LTCG of up to Rs. 1 lakh is tax-free. 

Why do these types of mutual funds carry high risks?

This is because these funds invest in companies with small market capitalisation, which can be negatively affected by price fluctuations in the stock market. Hence, these funds are a risky bet. That said, in comparison to other mutual funds, these schemes have the potential to generate higher returns. 

How can you reduce your risks on a small-cap fund?

You can pick a small cap fund that invests that offers high sectoral diversification. Also, you can look at other factors like past performance, the experience of the fund manager, and more. 

What kind of returns can you expect from small-cap funds?

Small cap funds can offer higher returns than other equity-oriented mutual fund schemes. That said the rate of return depends on various factors, such as the market scenario, experience of the fund manager, etc.  

How long will you need to invest in such funds?

A common rule of thumb for stock investments is that you need to have a long investment horizon owing to the market fluctuations. 

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