To make it easier for investors, fund houses usually classify mutual funds based on factors such as the market capitalization of companies. Here, mutual funds are classified into three different types - large-cap mutual funds, mid-cap mutual funds, and small-cap mutual funds.
Understanding the differences between these three funds is crucial since it can help you make the right decision as an investor. In this article, we’re going to be looking at small-cap mutual funds, the benefits that they offer, and the risks that they possess. So, let’s begin.
What are Small-Cap Mutual Funds?
In the list of companies by market capitalization, small-cap companies are all those entities that appear after the top 250 companies. And small-cap mutual funds are funds that invest the pooled money of the investors in these small-cap companies.
What are the Benefits of Investing in Small-Cap Mutual Funds?
Now, before we proceed to take a look at the risk in small-cap mutual funds, let’s quickly go through the various benefits that they have to offer.
Exceptional Return Generation Potential
small-cap mutual funds have the potential to give you exceptionally high returns compared to mid-cap or even large-cap funds. This has to do with the high growth potential that these companies have.
Low NAV
The Net Asset Value (NAV) of small-cap mutual funds generally tends to be very affordable. This allows you to purchase more units, which can have a significant impact on your returns if the market conditions are right.
Good Diversification
Investing in small-cap mutual funds allows you to diversify investment portfolio. This reduces your overall investment risk and increases your chances of staying protected even when the market is navigating headwinds.
What are the risks associated with small-cap mutual funds?
Despite the many benefits these funds offer, the risk in small-cap mutual funds is something that cannot be avoided. As an investor, you need to know what they are. Here’s a quick look at a few of the risks.
Highly Volatile
One of the significant risks associated with small-cap funds is that they’re very volatile and can experience wild swings in price. This makes them very risky to invest in since the losses can be quite significant if the price doesn’t move according to your expectations.
Low Liquidity
Institutional investors rarely invest in small-cap mutual funds. And even in the case of retail investors, the participation is usually not very high. This can lead to liquidity issues and make it tougher to buy or sell the units in the market.
Lackluster Performance
The performance of small-cap mutual funds is dependent on multiple factors, which include the selection of stocks, the performance of the selected stocks, and the timely intervention of the fund manager when it comes to balancing the fund. Due to so many variables being involved, the performance of small-cap funds may not be as stellar as one might expect it to be.
Conclusion
Now that you know the risk in small-cap mutual funds, make sure to consider them before proceeding to invest in them. Also, open a Demat account with Motilal Oswal if you don’t have one already. You will need one to invest in mutual funds and upcoming IPOs.