There were around 21 schemes that have completed three years in the market. Out of these, 20 schemes gave more than 30% returns. ITI Small Cap Fund was the only exception, which offered 23.53% in three years. The small cap category offered an average return of around 36.02% in three years. Quant Small Cap Fund, the topper in the category, gave 46.85% in three years. Nippon India Small Cap Fund, the next in the list, gave 43.09% in the same period.
Now, how did the small cap funds manage to offer such high returns? What contributed to this success? “There was a very sharp correction in small caps just before this three year period and therefore the returns have come out of low base in terms of the impact that they had from covid. So this is a very large reason why returns look disproportionately higher on a three year basis at this particular point in time,“ says Vishal Dhawan, CEO, Plan Ahead Wealth Advisors, a wealth management firm in Mumbai.
The category gave 18.40% and 22.71% in five and 10 year horizons respectively. Around 14 schemes have completed five years of existence in the market. Out of 14 small cap schemes, four schemes have offered more than 20%. Quant Small Cap Fund, the topper in the category, offered 27.63%, followed by Axis Small Cap Fund which gave 21.78%. Around 10 schemes have completed 10 years in the market, and out of these 10 schemes, seven gave more than 20%.
“As far as 10 year performance is concerned over very long period of time small caps do have the ability to outperform larger cap indices but they come with much higher volatility and therefore investors need to be comfortable with that higher volatility that comes with it if they want to participate and therefore need to have that long-term investment horizon if they are making investment,” says Dhawan.
Most mutual fund advisors believe that the valuations in the small cap space are high. Should investors still invest? Mutual fund advisors have been recommending investors to make staggered investments in these funds. “In the last few months at least a couple of small cap fund managers have stopped accepting lumpsum investments. So the excess valuations as well as the difficulty of dealing with higher flows in small caps is being demonstrated through the fund managers as well. I think it’s a good idea for them to be careful seeing the signals being given out by fund managers,” he added.
Small cap schemes invest in very small companies or their stocks. That is why investing in small cap stocks is considered extremely risky. The small cap segment can be extremely volatile in the short term, but they have the potential to offer very high returns over a long period. Small cap schemes are recommended only to aggressive investors with a high-risk appetite and long investment horizon, say, around seven to 10 years. ETMutualFunds do not recommend small cap schemes to new and inexperienced investors.
However, looking at the current performance and average returns by the small cap schemes, and getting excited about making investments, what strategy should one follow?
“Most investors depending on their risk tolerance having between 0-20% exposure to small caps is a good idea at a overall portfolio and if they don’t have anything as a new investor and have a high risk tolerance they can allocate upto 20% of their flows into small caps through a SIP or STP round. They need to have a 7-10 year of investment horizon whenever they buy equities for any sort of meaningful wealth to get generated,” says Vishal Dhawan.
If you are looking for recommendations, see: Best small cap mutual funds to invest in 2023
