Small-cap mutual funds are highly risky, and they provide high returns. The Net Asset Value (NAV) of a Small-Cap Fund is highly sensitive to underlying small-cap companies’ performance. The small-cap funds put a significant amount of their investible funds into small-cap companies’ equity or equity-related instruments. The market capitalisation of small-cap companies is very less as compared to large-cap schemes.
The large-cap funds are relatively safer since they invest in all the big companies. The bluechip/big companies have a large base and matured businesses, making them relatively stable during the market downturn. Small-cap funds are susceptible to volatility in the market. If the market bounces, these entities face the maximum jolt.
In such a situation, small companies may have irregular returns and cash flows. It makes the investors lose their confidence in such funds, and they tend to take out their money from small-cap funds. Such types of funds are generally recommended for high-risk appetite investors.
However, there is a big misconception that people can earn good returns only from large-cap funds. This concept is not always true. The small-cap funds have great potential to offer high returns. The companies have a smaller base and hence have much growth potential. If the company outperforms, it can give manifold returns as compared to large-cap companies. Therefore, it is recommended to keep a small portion of the portfolio in such small-cap funds.
During the pandemic, the market has seen a significant downturn which has adversely affected the small-cap companies. Even when the market does not perform well, such small companies’ market price sees a considerable fall. Hence an investor with greater risk tolerance must choose such investment options. Investment in small-cap funds may or may not give considerable returns in little time.
Companies with smaller bases need time to grow. Hence, investment in small-cap companies should be for the long-term horizon so that any fluctuations in the market will get mitigated and create wealth in the long term.
SIP is a systematic, regular investment in mutual funds. The SIP investment reduces risk due to rupee cost averaging. In simple terms, when NAV is low, you can acquire more units with the instalment amount, and when the NAV is high, you receive low units with the same amount. Hence, this averages the returns in the long run. Thus, SIP turns out to be a better option than a lump-sum amount.