10 Best Small Cap Mutual Funds to Invest in 2022

Small cap mutual funds are open-ended equity schemes that primarily invest in stocks of companies with small market capitalisation. These companies are relatively small in size but have significant room to grow. Further, small cap companies essentially have a market cap of less than INR 5000 crores.

Small cap funds invest at least 65% of their total assets in equities or equity-linked instruments of small cap companies. While these funds have the potential to generate high returns, they are highly volatile involving a high level of risk.

Now, let us check out the best small cap mutual funds in terms of their long-term returns.

List  of Top Small Cap Mutual Funds in India in 2022

The table below provides a list of the best small cap funds in India in 2022 based on their five-year annualised returns: 

How Do Small Cap Mutual Funds Work? 

Small cap companies are the ones that rank above 250 according to their market capitalisation. Market capitalisation is a company’s total value based on its prevalent share prices and the total number of outstanding stocks. To calculate the market cap, one must multiply the current market price of a company’s share by its total outstanding shares.

These companies have a market capitalisation of less than Rs. 5000 crores. The stocks of these companies carry the potential of growing two-fold in a short period. However, there are considerable risks associated with such investments as even the slightest market volatility impacts the share prices of small-cap companies.

For investing in small-cap schemes you need to have a long-term investment horizon, as small companies need time to grow. 

Who Should Invest in Small Cap Mutual Funds?

Given below are the details of investors who may consider putting their money in small cap funds:

• People with a high-risk appetite can consider this investment option. This is because these mutual funds are associated with high volatility. 
• Aggressive investors wishing to remain invested for an extended period can invest in these mutual fund schemes. 
• Moreover, investors must have the ability and patience to bear fluctuations in the short-term. Financial experts advise people to make investments in small proportions in small cap mutual funds. 
• An investor will not want more than 10% to 15% exposure in small cap equities. Moreover, investments in small cap funds should be aligned with the investor’s financial goals. 

Benefits of Investing in Top Small Cap Funds

Discussed below are the benefits of investing in the best small cap mutual funds: 

• As small cap mutual fund schemes focus on smaller companies with good prospects, investors can earn high returns. These returns have the potential to beat that of large cap funds in favourable market conditions.
• Small cap funds offer diversification in those portfolios that predominantly consist of large cap and index companies. Small cap funds invest in different sectors, including banking/financial, IT, automotive, FMCG etc., whose price movements often do not correlate to index stocks.
• If a small company has been performing well, there is a likelihood that they may get acquired or merge with their larger counterparts to grow inorganically. As a result, the share price of these companies may rise, adding value to small-cap funds.
• As they are relatively new and unknown, small cap companies are often undervalued. This means one can start investing in these companies at a relatively low price.

Risks Associated with Investing in Small Cap Funds

Discussed below are the associated risks of small cap mutual fund investments:

• These schemes carry inherent risks which make the portfolio extremely volatile. This is because small cap stocks are subject to sharp market movements. Further, smaller companies are not easily able to survive a financial crunch or economic downturn.
• As small cap companies are associated with limited liquidity, it affects the fund manager’s decision to trade underlying stocks. 
• Most of the small cap companies have growth stocks. In simpler words, they reinvest the profits back into their business. As a result, they do not pay dividends to their investors. 

Important Factors to Consider Before Investing in Small Cap Funds

Listed below are the important factors that investors must consider before investing in small cap mutual funds: 

• Financial Goals

With small-cap funds, you should invest for a longer term to make the most out of your investment. If you have a financial goal you need to fulfil in the coming 7-10 years such as retirement, debt payment, and education for children you can consider these funds.

• Risk vs Returns

Investors should assess if they have a high-risk appetite before investing. If they can bear the risks, these schemes will act as a buffer in their portfolio. 

• Research is needed: 

Owing to a large number of small-cap funds, it is difficult to find out which one will grow your investment or which one will not give appropriate returns. You must conduct proper research to select the fund with the best investment potential. Also, consider looking at the Small Cap benchmark and pick the funds that have performed better than it.

Taxation Policy of Small Cap Funds 

Small cap funds are taxed just like any other equity funds. The holding period of the small cap mutual fund units determines the taxation rate. 

For example, if the holding period is less than twelve months, the capital gains are considered STCG or short term capital gains. Here, the applicable tax rate is 15%. 

If an investor’s holding period is twelve months or more, the capital gains are considered LTCG or long term capital gains. If these gains exceed Rs. 1 lakh, the tax rate is 10% without indexation benefit. Otherwise, the capital gains are exempt from tax. 

FAQs about small cap mutual funds