Top Performing Small Cap Mutual Funds in India: High Returns, But What About the Risk?

Small cap mutual funds in India have made headlines for their impressive returns over the past year. With the top-performing funds delivering up to 67% returns in just one year, these funds have outpaced both major benchmarks in the small cap category. But while the returns may be tempting, it’s essential for investors to consider the associated risks and make informed decisions.

The Top 7 Small Cap Funds in the Last 1 Year

Here’s a look at the top 7 small cap mutual funds based on their 1-year performance (Direct Plans):

1. Bandhan Small Cap Fund: 67.11%
2. Invesco India Smallcap Fund: 55.72%
3. ITI Small Cap Fund: 54.88%
4. Mahindra Manulife Small Cap Fund: 52.89%
5. Quant Small Cap Fund: 49.73%
6. LIC MF Small Cap Fund: 49.58%
7. Tata Small Cap Fund: 49.45%

These funds have far outperformed the benchmark indices in the small cap category:

• BSE 250 SmallCap Total Return Index (TRI): 43.67%
• NIFTY Smallcap 250 TRI: 45.26%

This clearly shows that investing in small cap mutual funds can deliver remarkable returns in a short period. However, the high returns come with significant risks, which every investor should keep in mind.

Long-Term Returns: Performance Over 5 Years

Small cap mutual funds have also performed well over the long term. Over the last 5 years, the top 7 funds have delivered returns ranging from 34.59% to 48.80%. Here are the top 7 performers based on their 5-year returns:

1. Quant Small Cap Fund: 48.80%
2. Bank of India Small Cap Fund: 39.52%
3. Nippon India Small Cap Fund: 37.85%
4. Canara Robeco Small Cap Fund: 36.84%
5. Tata Small Cap Fund: 36.17%
6. Edelweiss Small Cap Fund: 35.47%
7. Invesco India Smallcap Fund: 34.59%

When compared to the benchmarks, these funds have consistently outperformed:

• NIFTY Smallcap 250 TRI: 32.08%
• BSE 250 SmallCap TRI: 31.48%

Why Small Cap Funds Show High Returns?

Small cap funds invest in smaller companies that are in the early stages of growth. These companies have higher growth potential, which can translate into substantial returns for investors. However, because they are still developing, they are also more vulnerable to market volatility, economic shifts, and business risks.

The Risks Involved in Small Cap Funds

While small cap mutual funds can deliver high returns, they are also riskier compared to large and mid cap funds. The primary risks include:

1. Market Volatility: Small cap stocks are highly sensitive to market fluctuations. During market downturns, these stocks can fall more sharply than large cap stocks.
2. Liquidity Risk: It may be harder to sell small cap stocks quickly without affecting their price, especially during volatile markets.
3. Business Risk: Since small cap companies are still growing, they are more prone to business challenges, such as management issues, competition, or lack of resources, which can affect their stock prices.
4. Economic Sensitivity: Smaller companies tend to be more affected by economic downturns or industry-specific problems. If the economy weakens, small cap stocks are likely to feel the impact first.

Because of these risks, small cap funds are often categorized as “very high risk” on mutual fund riskometers. For this reason, they should make up only a small portion of your overall investment portfolio.

Investment Strategy for Small Cap Funds

Considering the high risk and reward potential, it’s important to approach small cap funds with a balanced investment strategy:

• Diversification is Key: Rather than investing a large portion of your portfolio into small cap funds, diversify your equity investments across large cap, mid cap, and multi cap funds. Large cap funds offer stability, while mid cap funds offer a balance of growth and risk.
• Limit Your Exposure: Small investors should limit their direct exposure to small cap funds to 10% of their equity portfolio. This way, you can participate in the potential growth of small cap stocks without exposing yourself to unnecessary risk.
• Consider Multi Cap or Flexi Cap Funds: For a more balanced approach, consider investing in multi cap or flexi cap funds, which allocate a portion of their investments to small and mid cap stocks. This allows you to benefit from the growth potential of smaller companies while maintaining exposure to the stability of large cap stocks.

Should Retail Investors Invest in Small Cap Funds?

For retail investors, small cap funds can be an exciting opportunity for growth. However, these funds are best suited for those with a high risk tolerance and a long-term investment horizon. If you’re willing to ride out market volatility and potential short-term losses, small cap funds can provide attractive returns over time.

Before making any investment decision, it’s crucial to consult with a financial advisor. They can help you assess your risk tolerance, investment goals, and portfolio diversification needs.

Disclaimer: This article is for informational purposes only and does not constitute investment advice. Investments in mutual funds are subject to market risks, and it’s important to consult with your financial advisor before making any decisions.