Many mutual fund investors believe that investing in small cap mutual funds is the best way to pocket maximum returns. Even now, ETMutualFunds.com receives several queries from our readers asking whether they can invest in small cap funds. Sure, many investors are a bit scared to invest in small cap mutual funds now, as most of these schemes are bleeding heavily in the last few years. In the post-Covid-19 scenario, the prospects of these scheme also looks very bleak. Still, one can’t deny the lure of small cap mutual funds to investors, especially to the new comers to equity investments.
Okay, is there a safe way to invest in small cap mutual funds? What are the factors to keep in mind while choosing mutual funds? If one play it safe, is it possible to avoid losses in small cap mutual funds? There are many frequently asked questions when it comes to investing in small cap mutual funds. Here are a few pointers you may consider before investing in small cap mutual funds.
Before proceeding, you should get one thing straight. You simply cannot avoid risk and volatility totally if you are investing in small cap mutual funds. As you know, small cap schemes invest in very small companies that have a bright future. However, most of these companies have governance issues and they don’t live up to the promise. If these companies falters even a little, they would be punished severely in the stock market. The share prices may be reduced to zero in no time. This is the risk you are taking while investing in small cap schemes.
How do you overcome this threat? Well, you can never entirely avoid it, but you can take a few precautions to soften the blow. One, you should invest in small cap schemes only if you have a really long investment horizon. For example, do not invest in small cap schemes if you do not have at least seven to 10 years. This will give you some time to recoup your losses.
Two, never make small cap schemes the core portfolio. Small cap schemes always go through severe phases of ups and downs. So, they will not offer you stable returns. So, it is better to take a calculated exposure to them to add to your total returns.
Three, always opt for fund houses and managers who are known for their skills managing small cap schemes. Always keep in mind that investing in small cap schemes is extremely challenging – it is about identifying promising companies, taking meaningful stakes well in advance, and hold on to them patiently to make money. Only a very few fund managers have managed to deliver superior reruns over a long period.
Four, make sure the fund size is not very large. It is very difficult to find investment options in the small cap space. When you have a really large corpus, it becomes extremely challenging. That explains why many fund houses are forced to shut their schemes for subscription after a certain point. So, always choose a scheme with a small corpus.
Last, do not start investing in small cap schemes when you see huge returns posted by them and stop at the first sign of a fall. This is a sure way to lose money. If you panic about your investments during a bad phase in the market, it clearly indicates that you do not have the necessary risk appetite to invest in small cap schemes. If you have the necessary risk profile and a long-term invest horizon, invest in small cap schemes regularly over a long period, irrespective of the market conditions. That is the only way to make money on your small cap investments.
