Small Cap Mutual Funds

What Are Small Cap Mutual Funds?

Small-cap mutual funds are equity mutual funds that invest primarily in smaller listed companies. Under the Securities And Exchange Board Of India’s (SEBI) classification rules, small-cap companies are those ranked 251st and beyond based on market capitalisation. Many of these businesses are still in relatively early stages of expansion compared to large-cap and mid-cap companies.

Some companies might be expanding into newer markets, and others are still working on expanding their operation or trying to edge out the competition within the industry. That growth potential is one reason small-cap funds get so much attention from growth-orientated investors. At the same time, the price movement in this category can also be greater than the larger fund categories.

Key points about small-cap mutual funds:

• Investments are mainly made in smaller listed companies
• SEBI classifies companies beyond the 250th rank as small-caps
• Businesses in this category are often still in the process of expanding
• Market fluctuations can be relatively sharper than in large-cap or mid-cap funds
• The category is usually explored with a longer investment horizon in mind

How Do Small Cap Funds Work?

Small-cap funds pool money from different investors and deploy it across smaller listed companies. Fund managers keep reviewing the portfolio from time to time. Companies are tracked closely, along with sector trends and overall business performance. Fund returns eventually depend on how these businesses perform and grow over the years. Market conditions, however, can influence returns quite sharply in this category.

How small-cap funds usually work:

• Investor money is pooled into a common fund
  
• Investments are made across smaller listed businesses
  
• Different sectors may form part of the same portfolio at any given time
  
• Fund managers regularly track companies and market conditions
  
• Some stocks may be increased, reduced, or replaced based on portfolio strategy
  

Features Of Small Cap Mutual Funds

Small-cap funds behave differently from many large-cap and mid-cap funds.

Some common features include:

• Focus on smaller companies
  These funds invest mainly in businesses that fall under SEBI’s small-cap classification. Many of these companies are still in the process of expansion.
  

• Performance can move unevenly
  Small-cap funds do not always move steadily across market phases. In certain periods, fluctuations can become much sharper compared to large-cap categories.
  

• Companies from different industries may be included
  The portfolio usually includes more than one sector. Businesses from multiple industries can form part of the same fund. This creates wider market exposure within a single fund.
  

• Professional fund management
  Fund managers keep reviewing companies, sectors, and portfolio allocation regularly. Changes in the portfolio may also happen from time to time, depending on market conditions.
  

Benefits Of Investing In Small Cap Mutual Funds

Small-cap funds are often discussed by investors willing to stay invested for longer periods. Some businesses in this segment may continue growing steadily over the years. Benefits associated with small-cap mutual funds include:

• Possibility of higher long-term growth
  Some smaller companies may grow much faster than already established businesses over longer periods. This is one reason the category receives considerable attention from long-term investors.
  

• Access to smaller growing businesses
  Several companies in small-cap portfolios are still building scale and expanding gradually. Some may become much larger businesses over the years.
  

• Spread across multiple companies
  Investors usually spread the portfolio across multiple companies instead of depending heavily on only a few stocks. Businesses from different sectors may also be included at the same time.
  

• SIP investing becomes easier
  Many investors prefer building exposure gradually through Systematic Investment Plans (SIPs) instead of investing a large amount at once. This allows investments to continue across different market conditions.
  

Risks Of Small Cap Mutual Funds

Small-cap funds are often considered among the more volatile mutual fund categories. Market corrections can affect these funds quite sharply at times. Returns may therefore move unevenly over shorter periods.

Who Should Invest In Small Cap Funds?

Small-cap funds are not usually explored by conservative investors. The category is more commonly considered by people who understand that returns may fluctuate sharply at times.

This category may suit the following:

• Investors comfortable with higher market risk
  
• People planning to stay invested for several years
  
• Those who can handle short-term market fluctuations
  
• Investors looking beyond only large-cap exposure
  
• Individuals willing to continue through market corrections
  

Top 5 Small Cap Mutual Funds In India

The table below includes some of the best small-cap mutual funds currently tracked by investors. Historical performance, portfolio composition, and fund strategy are some commonly reviewed factors when comparing them.

Small Cap Mutual Funds Vs Mid Cap Funds Vs Large Cap Funds

The difference between these categories mainly comes down to company size. Bigger and more established companies usually form part of large-cap funds. Mid-cap funds, meanwhile, focus on medium-sized businesses. Small-cap funds move towards smaller businesses that are still expanding and building scale.

Taxation On Small Cap Mutual Funds

The taxation of small-cap mutual funds depends mainly on how long the investment is held before redemption. Since these funds fall under equity mutual funds, gains are divided into Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG).

A few additional points:

• Taxation applies only when units are redeemed
  
• SIP investments are taxed separately based on the purchase date
  
• Dividend income is taxed as per the investor’s income slab
  
• Tax rules may change in future
  

SIP Vs Lump Sum In Small Cap Mutual Funds

Both SIP and lump-sum investments are available in small-cap mutual funds. The choice usually depends on investment style, market comfort, and available capital.

How To Invest In Small Cap Mutual Funds?

Many investors take some time to compare platforms and small-cap funds before getting started. Fund history, portfolio mix, and risk levels are also checked quite closely during the selection process.

Steps to invest in small-cap funds on Kotak Neo:

• Login to the Kotak NEO App with your username and password.
  
• Look for the Invest option on the bottom navigation bar.
  
• Under Other Investments, select Mutual Funds
  
• Search for Small-Cap Funds
  
• Go through the available options and choose a scheme that suits you
  
• Tap on Invest Now
  
• Pick SIP or lump sum investment and enter the amount
  
• Accept the T&C, and click Proceed
  
• Complete the payment via UPI or Net Banking
  

Factors To Consider Before Investing In Small Cap Funds

Small-cap funds can behave very differently across market cycles. Because of these differences, investors often review multiple aspects before entering the category.

Important factors include:

• Risk appetite
  Small-cap funds do not always move steadily. Market swings can become quite sharp at times. Investors, therefore, usually assess how comfortable they are with temporary fluctuations.
  

• Investment horizon
  Short-term movements in this category can be quite sharp and unpredictable at times. So, this may be more suitable for investors with a multi-year outlook.
  

• Portfolio composition
  Portfolio concentration, sector exposure, and the number of holdings are all aspects worth examining before investing.

• Fund history
  Some investors compare how the fund has behaved during both strong and weak market phases instead of looking only at recent returns.
  

Why Are Small Cap Mutual Funds Popular Among Investors?

Small-cap funds have remained widely discussed among long-term investors for years. The category draws interest because smaller businesses can sometimes grow very differently over longer periods compared to established large-cap companies.

Reasons behind the popularity of small-cap funds include:

• Smaller companies may scale rapidly
  Some businesses in the small-cap space may continue expanding steadily for years. Investors often track this growth potential closely.
  

• The category looks different from large-caps
  Small-cap portfolios usually include companies that have not yet established themselves very widely in the market. This creates exposure beyond traditional blue-chip businesses.
  

• Higher return expectations
  Return potential is a key driver of interest for small-cap funds. Higher returns are not certain here. Still, the category continues attracting investors because many smaller businesses have significant room for growth.
  

• SIP investing has increased participation
  Regular SIP investing has made small-cap funds accessible to a wider group of investors over time. This is because smaller monthly investments have reduced the entry barrier for many people.
  

Mistakes To Avoid While Investing In Small Cap Funds

Small-cap funds can behave unpredictably during certain market phases. Because of these factors, investors often try to avoid decisions driven only by recent returns or market excitement.

Some common mistakes include:

• Entering after a strong rally
  Interest in small-cap funds often rises after markets move up sharply. By then, valuations in certain pockets may already be stretched. Entering during extremely overheated phases can increase risk.
  

• Ignoring risk levels
  Small-cap funds are not usually considered stability-focused investments. Investors entering the category without understanding the possibility of sharp market swings may feel uncomfortable during volatile phases.
  

• Expecting quick returns
  Business growth in smaller companies may take time. Performance, therefore, may not remain consistent every year.
  

• Stopping SIPs after markets fall
  Some investors stop their SIPs once markets turn weak or corrections become uncomfortable. Doing so interrupts gradual participation across different market conditions.
  

Disclaimer: This article is for informational purposes only and should not be considered investment advice from Kotak Neo. For compliance T&C and disclaimers, Visit www.kotakneo.com/disclaimer