As Indian investors navigate the bustling and ever-changing dynamics of financial markets, the question, “Should I invest in small-cap funds” becomes increasingly relevant. Small-cap funds focus on companies with relatively modest market capitalisation and present unique opportunities.
Let us explore the rationale behind considering small-cap funds, the potential advantages, as well as the challenges that come along. Now, we’ll start at the very beginning.
Small-cap mutual funds are the ones that have over 65% of their holdings in small-cap stocks. But, what are small-cap stocks? They are listed companies with market capitalisation below Rs. 5,000 crores. In terms of market capitalisation, they are ranked beyond 250. These companies, though considered riskier due to their size, also offer the potential for high growth and attractive returns.
1. High Growth Potential:
Small-cap companies in India are often in their early stages of growth, presenting substantial growth potential. Investing in these companies can lead to significant returns if they successfully navigate challenges and expand their market presence.
2. Diversification Benefits:
Introducing small-cap mutual funds to your portfolio can enhance diversification. Since small-cap stocks in India may not move in tandem with larger market indices, their inclusion can reduce the overall risk of your investment portfolio.
3. Opportunity for Early Entry:
Investing in small-cap companies allows you to get in on the ground floor of potential success stories. Early entry into Indian companies with innovative business models or disruptive technologies can result in substantial gains over time.
4. Contribution to Long-Term Growth:
Small-cap mutual funds can be viewed as a long-term growth strategy. While these investments may be more volatile in the short term, holding onto them over an extended period can allow you to ride out market fluctuations and benefit from the growth trajectory of successful small-cap companies.
Investing in small-cap stocks demands thorough research. You must understand the fundamentals as well as the technicals of the stock before investing. While not every investor is well-versed in doing equity research, they tend to invest in small-cap funds. These AMCs (Asset Management Companies) employ experts who research and choose small-cap stocks to invest in.
1. Higher Volatility:
Small-cap stocks are generally more volatile than their larger counterparts in the Indian market. This heightened volatility can result in larger price swings, posing challenges for investors who may be more risk-averse.
2. Market Liquidity Challenges:
Small-cap stocks in India may have lower trading volumes, leading to potential liquidity issues. Selling large quantities of shares in smaller companies could impact the stock price, and investors may face challenges in executing trades.
3. Increased Risk of Business Failure:
Smaller companies in India may be more vulnerable to economic downturns, industry-specific challenges, or management issues. This elevated risk of business failure should be factored into your risk tolerance and investment strategy.
The decision to include small-cap mutual funds in your investment portfolio hinges on your risk tolerance, investment goals, and time horizon. If you are comfortable with a higher level of risk and seek potential long-term growth, small-cap funds may be a suitable addition. However, if you prefer a more stable and predictable investment journey, a more conservative approach with larger-cap funds might be preferable.
Consulting with a qualified financial advisor who understands the intricacies of the Indian market can provide valuable insights tailored to your specific circumstances. This guidance will help you navigate the complexities of small-cap investments in India and make informed decisions that align with your individual financial objectives.