Mutual funds have struck a chord with working professionals looking to save for their future. People opt for a mutual fund investment to enjoy higher returns for securing their financial future. However, to earn high returns, you should choose the right type of mutual fund. One of these types is equity funds. As the name suggests, these funds invest in the equity market. Equity funds are also not a monolith. One of the types of equity funds is small-cap funds.

What are small-cap funds?

Small-cap mutual funds are equity funds that invest at least 80% of their corpus in equities or equity-linked instruments of companies that may grow over time. The most common types of equity funds are large-, mid-, and small-cap funds. Equity fund variants invest in companies across different market capitalisations. Large-cap funds invest in well-established businesses, and mid-cap ones invest in mid-sized companies. Small-cap funds, conversely, invest in businesses with high-growth potential.

What are the advantages of small-cap funds?

The advantages of small-cap funds are:

Growth potential:

Small-cap businesses operate in niche markets or emerging industries. This feature provides you with several growth opportunities. You are exposed to these businesses and benefit from their growth trajectory if they succeed by investing in small-cap mutual funds.

Undervalued opportunities:

Unlike large- and mid-cap stocks, small-cap stocks are less researched by analysts. The relative lack of attention can lead to the undervaluation of these companies. Skilled fund managers can identify these undervalued opportunities and leverage them. With the help of small-cap funds, you can enjoy the potential benefit of capital appreciation.

Long-term capital appreciation:

Small-cap funds are suitable for long-term investors with a high-risk appetite and a long investment horizon. While small-cap funds are volatile, they have the potential for substantial growth over time. You can benefit from compounding returns and generate significant wealth in the long term through small-cap equity mutual fund investments.

Regardless of the benefits, you should identify the investment amount. When you invest in a small-cap fund monthly, use a SIP calculator.

What are the risks associated with small-cap funds?

Four types of risks are associated with small-cap funds. They are:

Liquidity risk:

Small-cap trading is limited because of low liquidity, meaning you can’t purchase or sell large quantities of small-cap shares in a limited time.

Market risk:

Usually, small-cap businesses have limited customers and relatively small market share. These factors make small-cap stocks susceptible to higher levels of price fluctuations. Factors like changing economic conditions and performance cause price fluctuations, adding to the volatility associated with small-cap performance.

Credit risk:

Small-cap businesses have smaller cash flows. Yet, they require high capital for continuous growth. Hence, these businesses acquire higher debt in contrast to their size. High debt increases the credit risk of small-cap funds, i.e., the chances of these companies defaulting on their repayment are higher, unlike large-cap companies.

Event risk:

These companies are newer players with a constantly evolving business model affecting the bottom line because of unforeseen events like government regulation changes, a new taxation regime, etc. These factors add to the overall risk of small-cap equity fund investments.

Conclusion:

Despite all the risks, small-cap funds provide the opportunity to enjoy long-term capital appreciation. So, what are you waiting for? Invest in a small-cap fund already.