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Small-cap Equity Funds are those which invest in equity shares of companies which have smaller capitalization and listed under the 250th rank of the underlying benchmark.

This article covers the following:

  1. How do Small -Cap Equity Funds work?
  2. Who should invest in Small-cap Equity Fund?
  3. Things to consider as an investor
  4. How to Invest in Small-cap Equity Funds?
  5. Top 5 Small-cap Equity Funds in India
  6. Conclusion

 

1. How do Small-Cap Equity Funds work?

The “cap” in small-cap stocks refers to a company’s capitalization as determined by the total market value of its publicly traded shares. Small-cap stocks are generally defined as the stock of publicly traded companies that have a market capitalization ranging less than ₹500 crores. Technically speaking as underlying companies are young and seek to expand aggressively, they are more volatile and vulnerable to losses during downtime in the market. In a Small-Cap fund, the fund manager can have exposure to stocks of small companies in the range of 65%-90%.

Small-cap stocks give individual investors an edge over institutional investors. This is because institutional investors prefer to purchases large-cap stocks due to its stability, while Investors hoping for aggressive returns will invest in these funds.

Further, fund composition plays a vital role and an impulsive decision will endanger your returns. It makes sense to invest in multiple funds, so you have a diverse selection of small and mid-cap funds in your portfolio.
 

2. Who should invest in Small-cap Equity Fund?

The investor who has the capacity to stomach higher risks can consider investing in this category. One must have a small composition allocated in his/her portfolio towards small-cap funds. When an investor is creating a stock portfolio for himself, it is important to have a benchmark against which you can compare your returns. Comparing against a benchmark allows an investor to accurately gauge the actual performance of his or her portfolio. The best strategy to reduce risk can be investing through a SIP (Systematic Investment Plan).

 

Fund composition

 

We can also say that avoiding investment in small-cap fund can’t be a prudent way to deal with it. In fact, such an escape might prevent you from enjoying its magical return generating potential. One must learn patience while dealing with these funds, else it won’t take long to erode the gains made by your portfolio owing to faulty switches or redemptions.
 

3. Things to consider as an investor

a. Risk

Small-cap funds suffer from market risk i.e. the Net Asset Value (NAV) of the fund fluctuates along with the movements of the underlying benchmark. Times when the market is not performing, small-cap funds suffer a lot as they are less-established and opt to move out of business. On the other hand, it’s a great investment avenue for those who can tolerate more risk and are looking for more aggressive growth.

b. Returns

In the last couple of years, the market has seen the small category perform exceptionally well and has also attracted a lot of investor interest and money in this category. Small-cap funds are presumed to have significant yet hidden potential to be a “multi-bagger” (Indian financial jargon for equity stock which gives a return of more than 100%) one day.

c. Cost

Small-cap equity Funds charge an annual fee to manage your money which is known as the expense ratio. SEBI has marked the upper limit for this at 2.50% of the average asset under management. A lower expense ratio translates into higher returns at the end of the day. So, while shortlisting a fund, look for one which has the lowest expense ratio.

d. Investment Horizon

Small cap fund faces substantial erosion of returns when the market starts going downwards. Hence, in order to allow the fund to generate returns according to your expectations, you need to stay invested for a long term. A long-term investment horizon is when you consider this option for a time horizon of 7-10 years.

e. Financial Goals

Small-cap Equity Funds can be ideal for investors who may have long-term goals like planning for your children’s education, saving for your retirement, taking an exotic vacation with your family, paying off your medium-term debt, and so on. Historically, these funds have delivered higher returns as compared to the benchmark. However, these can become highly risky bets. Thus, those who have a high-risk appetite may think of investing in these funds. These funds invest in companies which have a great potential to generate good returns.

 

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f. Tax on Gains

When you redeem units of small-cap equity funds, you earn capital gains. These capital gains are taxable in your hands. The rate of taxation depends on how long you stayed invested in these funds; such a period is called the holding period.

Capital gains earned on the holding period of up to one year are called short-term capital gains (STCG). STCG are taxed at the rate of 15%. Conversely, capital gains made on holding period of more than 1 year are called long-term capital gains (LTCG).  Owing to recent changes in budget 2018, LTCG in excess of Rs 1 lakh will be taxed at 10% without the benefit of indexation.
 

4. How to Invest in Small-cap Equity Funds?

Investing in Small-cap Equity Funds is made paperless and hassle-free at ClearTax.

Using the following steps, you can start your investment journey:

Step 1: Sign in at cleartax.in

Step 2: Enter your personal details regarding the amount of investment and period of investment

Step 3: Get your e-KYC done in less than 5 minutes

Step 4: Invest in your favorite small-cap equity fund from amongst the hand-picked mutual funds
 

5. Top 5 Small-cap Equity Funds in India

While selecting a fund, you need to analyze the fund from different angles. There are various quantitative and qualitative parameters which can be used to arrive at the best small-cap equity funds as per your requirements. Additionally, you need to keep your financial goals, risk appetite and investment horizon in mind.

The following table represents the top 5 small-cap equity funds in India based on the past 5 year returns. Investors may choose the funds based on a different investment horizon like 3 years or 10 years returns. You may include other criteria like financial ratios as well.

 

Fund Name Returns
1 year 3 year 5 year
HSBC Small Cap Equity Fund 19.5 17.88 28.81
Franklin India Smaller Companies Fund 14.62 17.55 30.64
DSP BlackRock Small Cap Fund 9.02 18.99 33.66
SBI Small & Midcap Fund 36.67 25.49 36.16
Reliance Small Cap Fund 22.48 24.92 36.8

Note: The order of funds doesn’t suggest any recommendations. Investors may choose the funds as per their goals. Returns are subject to change.
 

6. Conclusion

Many times investing in liquid funds might be a jittery activity. In case tracking financial markets isn’t your thing and you are finding it too difficult to understand, then just go for ClearTax Save. You can invest in hand-picked funds in a hassle free and paperless manner.

 

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