Small Cap Mutual Funds typically include companies low market capitalization. Generally speaking, smaller companies are those in the early stages of business. They are presumed to have significant growth potential, but are not as financially strong or as established as larger companies.
Because Small Cap Funds invest in companies that are less stable than large-cap companies, the funds can be quite volatile. This has its advantages and disadvantages. In times of market instability, Small Cap Funds can suffer greatly as less-established companies go out of business. On the other hand, small-cap funds can also be great investments for those who can tolerate more risk and are looking for more aggressive growth. Investors hoping for aggressive returns will certainly want to park some money behind these funds.
- To be a part of Satellite Portfolio.
- Provides Kicker Returns to your overall portfolio.
Approximate Returns Possible:
15% – 30%
Criteria for choosing these funds:
- Fund Returns – Rather than chasing High Peak Returns across the categories, preference was given to consistent High Returns.
- High Alpha – Alpha tells you whether the fund has produced returns justifying the risks it is taking. It does this by comparing its actual return to the one ‘predicted’ by the beta. Say, a fund can be expected to earn a return of 15 per cent in a year (based on its beta). However, it actually fetches you 18 per cent. Then the alpha of the fund is 3 (18 – 15 = 3). In other words, alpha is a measure of selection risk (also known as residual risk) of a mutual fund in relation to the market. A positive alpha is the extra return awarded to the investor for taking a risk, instead of accepting the market return.
- Lower Standard Deviation – Standard Deviation (SD) of a fund depicts, that how much the returns of the fund have deviated from the mean level. The higher the value of standard deviation, the greater will be the volatility in the fund’s returns.
- Fund Risk Grade – The risk of investing in a mutual fund not only includes the possibility of losing money, but also the chance of earning less than you would have on a guaranteed investment.
- High Sharpe Ratio – Sharpe ratio represents this trade off between risk and returns. At the same time it also factors in the desire to generate returns, which are higher than those from risk free returns. As standard deviation represents the total risk experienced by a fund, the Sharpe ratio reflects the returns generated by undertaking all possible risks. It is thus one single number, which represents the trade off between risks and returns. A higher Sharpe ratio is therefore better as it represents a higher return generated per unit of risk. The Sharpe ratio is one of the most useful tools for determining a fund’s performance.
- High Sortino Ratio – One refinement of Sharpe is the Sortino Ratio, which uses only downside variance. It is the statistical tool that measures the performance of the investment relative to the downward deviation. The Sortino ratio is similar to the Sharpe ratio, except it uses downside deviation for the denominator instead of Standard Deviation (SD).
- R-Squared – The R-squared value shows how reliable the beta number is. It varies between zero and one. An R-squared value of one indicates perfect correlation with the index. Thus, an index fund investing in the Sensex should have an R-squared value of one when compared to the Sensex. For diversified equity funds, an R-squared value greater than 0.8 is generally accepted to mean that the underlying beta value is reliable and can be used for the fund.
- Beta – Beta is a statistical tool, which gives you an idea of how a fund will move in relation to the market.
- Expense Ratio – Expense ratio is the percentage of total assets that are spent to run a mutual fund. This involves the fund management fee, agent commissions, registrar fees, and selling and promoting expenses. All this falls under a single basket called expense ratio or annual recurring expenses. Expense ratio states how much you pay a fund in percentage term every year to manage your money. For example, if you invest Rs 10,000 in a fund with an expense ratio of 1.5 per cent, then you are paying the fund Rs 150 to manage your money. In other words, if a fund earns 10 per cent and has a 1.5 per cent expense ratio, it would mean an 8.5 per cent return for an investor. Since this is charged regularly (every year), a high expense ratio over the long-term may eat into your returns massively through power of compounding. For example, Rs 1 lakh over 10 years at the rate of 15 per cent will grow to Rs 4.05 lakh. But if we consider an expense ratio of 1.5 per cent, your actual total returns would be Rs 3.55 lakh, nearly 14 per cent less than what would have been achieved without any expense charge. Securities & Exchange Board of India has stipulated a limit that a fund can charge. Equity funds can charge a maximum of 2.5 per cent, whereas a debt fund can charge 2.25 per cent of the average weekly net assets. Lowest Expense Ratio is not considered here because it may mean lower returns also because of low involvement of high quality teams to manage the funds. To keep the expenses low, investment in Direct plans of corresponding Mutual Fund can be chosen.
Taxation / Expenses:
No tax to be paid on redemption if Units held for more than 1 Year. Barring a few funds, many of the funds do not charge any Exit Load if the redeeming after 1 year.
For Many of the funds, once the redemption request is placed the funds will come in bank account within 3-5 working days.
- IF SIP is done, then while withdrawl we need to take care that we can redeem only those number of units which have completed 1 Years of period to avoid Exit Load and Tax.
- It is advisable to invest in Joint Holding.
- Exit load will differ with respect to different funds.
- Please read the Fund Factsheet for more details before investing.
List of Funds:
We have shared the top picks among Small Cap Equity Mutual Funds based on the criteria as mentioned in the article.
Small cap mutual funds can deliver substantial gains especially when the economy is on the recovery mode.
Depending on your Risk Profile, it is advisable to make these mutual funds as a part of your Satellite Portfolio to give a kicker returns to your overall portfolio.