Small-cap stocks are the stocks of publicly traded companies that have a market capitalization of less than Rs. 5,000 crore. Such companies are more volatile and vulnerable to losses during downtime in the market, as they are young and seek to expand aggressively. In a small-cap fund, the fund manager invests a minimum of 65 percent of the portfolio in small-cap stocks. Having said so, small-cap funds are suitable for those who are willing to take high risks and also know when to exit the market which is easier said than done.
New companies that are available at a lower price, small-cap funds usually invest in such companies, as they may be undervalued. As these funds focus on newer concepts and invest in companies that focus on disruptive technologies, they could attain a competitive advantage over rivals acquiring significant market share.
Small-cap funds invest in stocks of companies that have short boom and bust cycles. Hence, these funds are only suitable for aggressive investors who knows when to enter and exit their holdings. Experts say this is the only instance when investors might have to time the markets to maximise their returns. In recent times, small cap funds have gained a lot of attention from investors given that last one year returns of these funds have been substantially higher than large and mid-cap funds. In this article, we evaluate if there is merit to have small cap funds in a portfolio.
|With 10% small cap within Equity Funds|
|Average Returns||*Standard Deviation||Skewness Above Average||Skewness Below Average||Worst Abs. loss||Value of 10 crs in 10 years|
|Without small cap within Equity Funds|
|Average Returns||*Standard Deviation||Skewness
|Value of 10 crs in
Source : Anand Rathi Research
* Standard Deviation is calculated for a 3 year rolling return with a monthly shift from Jan’ 2001 – July’ 2021.
As can be seen above, having a 10% small cap exposure within equity funds would mean:
Therefore, there is no merit to have small cap at a portfolio level.
2. Secondly, a comparison of small cap funds to other category of funds for various holding periods between 2011 – 2021, on return and risk parameters looks as below:
|Rolling Return||Large Cap average||Mid Cap Average||Small Cap Average||Flexi cap Average||Focused Average|
|Holding Period||Risk Parameters||Large Cap average||Mid Cap Average||Small Cap Average||Flexi cap Average||Focused Average|
* Standard Deviation is calculated for a 1 year, 3 year and 5 year rolling return with a monthly shift from Jan’ 2011 – July’ 2021
Efficiency Ratio Comparison
|Return per unit of Risk||Large Cap average||Mid Cap Average||Small Cap Average||Flexi cap Average||Focused Average|
Source : Anand Rathi Research
As can be seen in above return and risk analysis, one may be better off investing in midcaps than small cap mutual funds. However, small cap investing is relatively more fund manager dependent and only if a good fund manager can be identified with consistent track record, one can consider a small cap allocation with an understanding of the higher volatility attached to it.
(The author Rishabh Adukia is a Chartered Accountant and qualified professional advising on wealth management to individuals, millennial’s, emerging HNIs including others and can be reached on [email protected])