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Is it the right time to invest in small cap funds?

PUNJAB NEW EXPRESS | August 12, 2020 04:21 PM

Is small cap a good investment, particularly in the current scenario? This is one question that has possibly been playing on the minds of investors amidst the COVID-19 pandemic where the market is seeing renewed acceptance of lump sum deposits by many of these funds. Experts feel that it could be a smart move to deploy an investment in small cap funds at this juncture although timing the market correctly is necessary for enhancing long term gains.

Before you check out small cap funds like Canara Robeco small cap fund or other funds currently available in the market, you should delve deeper into the basics of these products and what they entail. Many investors select small cap mutual funds in suitable proportions and keep holding onto their investments for a longer period of time. They also keep rebalancing their portfolios regularly at least once every calendar year or quarter. Keeping an eye on market trends will help you identify the best time to make these investments. For instance, during a correction in the market by end-2018, stocks came down by approximately 20% from their earlier high thresholds. Early last year, interest rates were being lowered actively and this turned out positive for small cap funds.

Hence, taking that approach to heart, it could be a good time to purchase small cap stocks when the market has been going downwards for a sustained duration. It may be so that the market has reached its lowest ebb without any optimism amongst investors. This may be tough to anticipate accurately although keeping an eye on movements and investor sentiment is recommended.

Why should I invest in small cap mutual funds?

If you have been grappling with the above question, you should know that smaller companies may start rebounding faster in developing economies and this could even be faster than several bigger entities. Their collective destiny is not directly linked to rates of interest and they may grow on the basis of other economic aspects.

Smaller companies may be able to move quickly and make faster decisions regarding products, services and operations owing to fewer management/executive layers and lesser obstacles overall. When the economy starts recovering from any downward slump, small cap stocks will be responding quicker to the positive environment in the market and they may witness swiffer growth in comparison to large cap counterparts. Hence you can consider checking out some of the renowned and large and mid cap funds like Quant large and mid cap fund or small cap counterparts in the current scenario. Smaller companies usually raise a majority of their capital requirements by selling their shares in the market. You can choose between the following types of small cap funds:

  • Actively Managed- These are funds with active management where the fund manager has complete discretion on the stocks to be sold/purchased and timing of trades. Successful fund managers may ensure great returns for investors.
  • Passively Managed- Funds in this category do not aim at generating exceptional returns. They rather track underlying index performance in a passive manner. The cost of managing these funds is on the lower side with considerably smaller expense ratios as well.

Small cap funds are usually perceived by experts as more aggressive investment options in comparison to large cap funds. This is because smaller companies may be more vulnerable to economic fluctuations and stock prices may decline sizably during any economic recession as well. However, during a time of economic revival or recovery, small cap stocks may witness a substantial rise in prices which could be faster than large cap stocks. If you wish to tap into the benefits of fluctuations in prices, you may consider buying more small cap fund stocks. However, timing the market properly is vital for optimizing returns on your investments.

The key take-aways

Is small cap a good investment in the present circumstances? Nowadays, several large fund houses have also commenced taking lump-sum investments for small cap funds that they operate. In the current scenario, the BSE Small Cap Index has dropped by a whopping 25% (year to date) and a correction has taken place across sectors with BSE Mid Cap and BSE 100 coming down by a considerable 24% and 25% respectively. For tapping this new opportunity in the market, many fund houses are now open towards accepting investments in small cap funds.

As per reports, the rolling return over 5 years between 2005 and 2020 indicates that the category has surpassed the S&P BSE Small Cap TRI by a handsome margin. 13% compounded annual growth rate (CAGR) has been observed for small cap funds while 9.37% was the benchmark yield for average returns in this timeframe. Returns are handsome over the long haul although volatility may impact these funds for shorter time periods as has been seen till now. Choosing the right stock is of paramount importance since small cap funds will seem more attractive in comparison to 2017 from the valuation standpoint.

Some other vital things to remember

They are more diverse in the portfolio owing to greater cash flow and earnings uncertainty. This makes choosing the right stock even more important. However, you can give it a shot since small cap stocks are nimbler than large cap counterparts and if a market recovery is in the offing, they may respond better to the positive changes. You must have ample risk tolerance for absorbing higher levels of market volatility along with an investment timeframe of at least 7-10 years on an average. Experts recommend fund sizes between RS. 500-1, 500 crore and investing through SIPs (systematic investment plans) will be better than putting in a lump sum amount at one go. Some experts feel that investors should stick with their present small cap allocations without increasing it rapidly only because some funds are now taking lump sum investments.

On a closing note

Corrections have been visible across the mid cap and large cap segments as well. Disproportionate allocation enhancements are not advisable for small cap funds. The year 2020  has hindered earnings projections and predictions cannot be accurately made on the basis of the PE multiple in the current market scenario. Invest in a staggered manner in small cap funds in case you do not have any previous allocation in this category. Invest in a mixture of fixed income, equity, gold funds and international funds for portfolio diversification. Always, consult your financial advisor or take professional help before investing.

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