Small Cap Funds are the most misunderstood of major mutual fund categories. In this video, ETMONEY’s Shankar Nath and Tata Mutual Fund’s Mr. Chandraprakash Padiyar, help you decode the small cap funds. They tell you everything you need to know before investing in small cap funds.

Topics covered in this video:
00:00 Introduction
01:07 Definition of small caps
03:30 How have small caps performed?
06:56 Are small cap funds risky?
08:37 When to enter and exit small cap funds?
12:28 Is now the right time to invest in small cap funds?
16:28 ETMONEY's Opinion

👉 What are Small Caps?

In this section, we talk about how there was no clear definition of small cap prior to 2018 and how it has changed after 2018. Prior to 2018, there was no consistent definition which probably means that comparing two large cap, two mid cap or two small cap funds might have some irregularities. In that context, it will be better to give a fund’s more recent performance a higher consideration than its 5 or 7-year performance

The large universe of companies that the small cap fund managers have to work on. With over 5,000 listed companies on the Indian stock exchanges, it seems a little unfair how companies have been divided between large, mid, and small companies.

There are 100 large cap companies, 150 mid cap companies and 5,000 small cap companies. And while most of these 5,000 small caps are not investible, to choose 30-40 small caps from such a big universe of companies makes stock picking or active fund management a very important skill.

👉 How have small caps performed?

Here we talked about the performance of the Nifty small cap 100 index in the last 13 years. The Nifty Small Cap 100 index touched the 6,000 mark in January 2008. Today it stands at around 5,700. On the outside, it looks flat but when we look at the performance more closely it tells a different story.

The small cap index grew sharply between 2004 and 2007. Then in 2008, the index fell by 72% which wiped off 80% of the gains made in the preceding 4 years. And then there was a second bull run from 2009 until 2017. When the small cap index grew by over 400%. In 2018 - small caps had a correction and in the last three years have lost almost 40% in value.

Indices across market caps take a meandering course over many years which are a function of multiple things like earnings growth, overvaluation, undervaluation, bull markets, sentiments, etc. If one can manage the drawdown periods, small caps offer some strong periods of substantial wealth appreciation with annualized returns often crossing 20%.

👉 Are small cap funds risky?

In this section, we talked about how investing in small cap funds when the time is most opportune not only keeps your risks low but also improves your chances of making high returns.

We also talk about liquidity risk. Liquidity risk refers to times when the fund manager finds it difficult to sell some stocks which have an adverse effect on performance or on honoring redemption commitments. In the small cap companies, generally, the amount of free float or public shareholding is much lower than large cap funds

👉 When to enter and exit small caps?

In this section, we discuss that an investor should invest when small caps are undervalued and exit when small caps are overvalued. We also talk about how the PE ratio and Relative valuation help you in knowing if the markets are undervalued or overvalued.

👉 Is now the right time to invest in small caps?

The PE Ratio and the relative valuation of small caps in comparison to large caps, both indicators seem to suggest that presently small caps are relatively undervalued. Hence, it makes sense to invest in them at the current moment. Mr. Padiyar discussed a few key pointers to understand the direction of smaller companies in today’s environment.

👉 ETMONEY Opinion

For us, small cap funds are tactical plays. If the conditions are suitable, it makes perfect sense to invest in small caps. And when the conditions go bad, then an investor should have the resourcefulness to exit small caps.

In this section, we looked at what those conditions are and how to identify whether it is the right time to enter or exit small cap funds. Additionally, since small cap funds tend to have periods of massive gains and massive falls - it is advisable to dedicate a small portion of your portfolio towards small caps.

Overall, the small cap funds are an important part of every investor’s portfolio and can be used intelligently to make above-average portfolio returns through smart and calculative investing.

#SmallCaps #SmallCapFunds #ETMONEY

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