What are small cap funds?

SEBI has defined small-cap funds using a market cap based classification as part of its mutual fund categorization methodology. Large-cap stocks are defined as the top 100 stocks. Mid-cap stocks are those that rank between 101 and 250, whereas small-cap stocks are those that rank higher than 251. A small cap fund's corpus must be allocated to these small cap equities at a minimum of 65%.

Small cap mutual funds meaning

Small-cap funds mainly focus on purchasing shares of companies with low market capitalization. A firm’s overall stock value is market capitalization, calculated by multiplying the stock price with outstanding shares.

Important points to consider before investing in small-cap funds

Investing in small-cap funds can offer high growth potential but comes with increased risk. Here are some of the important points to consider before investing in small-cap funds:

1. Investment universe: Stocks of small-cap firms, which are often characterized as those having a market capitalization below a certain threshold, are the focus of small-cap funds.

2. Growth potential: Small-cap companies are sometimes seen to have more room for expansion. These businesses may only be getting started, but they have a lot of room to expand in terms of market share and profitability.

3. Risk and volatility: Small-cap funds have a greater risk and volatility profile despite their growth potential. The stock prices of smaller firms may be more volatile due to their heightened sensitivity to market changes and economic downturns.

4. Diversity: By including a variety of small-size equities in their portfolios, small-cap funds help investors achieve diversity. Diversification helps in distributing risk across many businesses and industries.

5. Market conditions: Small-cap funds might perform better than other stocks during periods of prosperity and investors’ confidence. However, they might be weaker due to market downswings or economic changes.

6. Long-term investment: Small-cap fund purchasing is generally considered a long-term investment program. Short-term volatility is expected. Hence, investors should take their time and wait.

7. Risk Tolerance: Before purchasing small-cap funds, investors should evaluate their level of risk tolerance. These funds could see more price changes than those investing in bigger, more established firms.

8. Research and Due Diligence: Extensive research and due diligence are essential given the nature of small company investing. Investors must know the small-cap firms in the fund's portfolio, including their business strategies, competitive environments, and growth prospects.

9. Performance Monitoring: Regular evaluation of the fund's performance and portfolio modifications may be required depending on changes in the market and the overall investment plan.

10. Investment Objectives: Investors prioritizing long-term capital gain and greater risk tolerance may find small-size funds appropriate. Investors should match their fund selection to their unique investing goals.

Small-cap funds may be a useful addition to a diversified investing portfolio with the potential for large growth. However, before investing in these funds, investors should carefully examine their individual risk tolerance and investing goals owing to their higher risk profile.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.