Small-cap funds can reward investors with strong long-term growth, but they are not for the faint-hearted. Frequent volatility, deeper drawdowns, and liquidity risks mean investors should enter gradually and stay invested through market cycles. Here’s a look at what strategy you should follow when investing in small-cap funds? Also, how much should they be part of your portfolio?
“Small‑cap schemes can play a constructive role as a growth sleeve within an equity portfolio, but they are highly volatile. There can be high‑drawdowns and therefore require a longer time horizon and careful sizing rather than blanket allocation advice,” asserts Arijit Sen, SEBI Registered Investment Adviser, Co-Founder, Merry Mind.
Also, investors should expect larger cyclical swings and deeper corrections than in large‑cap or diversified equity funds; the objective is to capture long‑term alpha from smaller companies while accepting episodic volatility and liquidity or governance risks that are more common in this universe, he add.
Key things to consider while investing in small caps:
- First, always try to treat small‑cap exposure as a complementary growth allocation rather than the extreme core of an equity portfolio.
- When taking exposure to small cap funds, one can consider systematic entry methods such as SIPs or staggered lump sums over 12–24 months. This helps to average out a volatile segment and reduce timing risk.
- Investors should try to maintain a minimum investment horizon of 7+ year, in fact preferably 10+ years, to give the strategy time to work through cycles.
- Also, reassess holdings on an annual basis and act only when there is a change in the fund’s mandate, process, or key personnel rather than short‑term performance swings.
What should you consider while picking small cap funds?
In selecting funds, the few things that needs to be considered includes – consistency, manager experience in the small‑cap universe, portfolio construction (watch top‑holdings concentration and sector tilts), reasonable expense and turnover, and the fund house’s research depth.
Also, be mindful of liquidity and governance risks inherent to smaller companies and the potential for sector or thematic concentration that can further amplify outcomes.
Noting that this is a general perspective intended for publication and not personalised advice, Sen pointed out, “individual investors should consider their own financial situation, objectives and constraints, and may wish to consult their adviser for recommendations tailored to their circumstances.”