Why small-cap funds give high returns?
Small Cap Funds invest in all companies except the top 250 in terms of market capitalization. Though these funds are relatively riskier and volatile in the short to medium term than other equity-oriented funds, they promise a higher upside of return in the long term.
If you have a greater risk tolerance and longer time horizons, small-cap stocks tend to outperform big-caps over time because they are able to grow more rapidly than larger companies. If you prefer stable appreciation and dividend income, big-caps may be more suitable.
Potential for growth: Because these companies are smaller, they have more potential for growth relative to large-cap companies. This means investors in them have the potential to make a large profit.
Some experts say small caps may do better than large caps during inflationary environments because it's easier for them to pivot and make changes, such as quickly raising prices or finding new sources for goods and materials.
Small-cap companies in India have seen continuous growth and outperformance in the stock market over the past decade. Research shows that small-cap stocks have yielded higher returns than large-cap stocks due to their inherent riskiness.
The Bottom Line
While small-cap stocks can generate higher returns, they also have a higher risk profile. Conversely, large-cap stocks witness smaller growth but are more stable. Investors should consider investing in both for a balanced portfolio.
Small-cap mutual funds are very risky. This means that in the short term, investing in them could lead to short-term losses. If you cannot tolerate seeing negative returns on your investments at specific periods, you should stay away from small-cap funds.
The small cap funds offered an average return of around 12.47% in a five year period. Small cap schemes are benchmarked against Nifty Smallcap 100 - TRI, Nifty Smallcap 250 - TRI, and S&P BSE 250 Small Cap - TRI. All these 19 small cap schemes returns ranging between 8.64 - 31.01% in a five year period.
Small caps are also more susceptible to volatility due to their size. It takes less volume to move prices. It is common for the price of a small-cap stock to fluctuate 5% or more in a single trading day. That is something that many investors simply cannot stomach.
Not only have small-cap stocks historically outperformed their larger peers, but they've done so strongly, by an annual average of more than 300 basis points (bps), and consistently, more than 69% of the time (Figure 1).
Do small-cap stocks do well in a recession?
Over the past 11 recessions, small caps have beaten their larger cousins by over 16% during the 12 months after a recession started. Consider the periods before and after the dot-com crash.
So quality is key. Over 41% of the small-cap index is unprofitable compared to 17.5% in mid cap and 7% in large cap. Profit growth for the S&P 500 is estimated to be 12% in 2024 after tracking slightly down in 2023.
Based on consensus earnings per share, we expect small-cap profits to grow faster than large-cap profits in most regions in 2024. In addition, the headwinds of rising interest rates faced by small-caps — especially small-cap growth stocks — appear to be on track to diminish or reverse.
Credit risk — The cost of borrowing is higher for smaller companies. Indeed, the cost of equity is higher, too. Lower average valuations for share buyers translate into higher cost for the companies issuing those shares. This is consistent with the underperformance of smaller company shares when times are tough.
In the subsequent seven years ending November 30, 2023, small caps returned 46.25 percent, compared to the S&P 500 generating returns nearly triple that mark at 130.9 percent. Small-cap stocks are historically cheap.
High Growth Potential
Small cap funds primarily invest in companies with smaller market capitalisations, which often have significant growth potential. These companies are at an early stage of development and can experience rapid expansion, leading to higher returns for investors.
Reasons why NOW might be a good time: Strong economic growth: India's economy is projected to continue growing, potentially benefiting small-cap companies as they tend to be closely tied to domestic growth. Market rally: Small-cap stocks have performed well in recent yea.
If your equity allocation is at least 5% higher than the target overall allocation, sell some small cap and invest in fixed income to reset.
In an analysis of foreign and U.S. investments from December 1998 through June 2023, researchers at index provider MSCI found that small-cap stocks outperformed large firms over 15-year periods about 9 in 10 times.
| Fund Name | Fund Category | 5 Year Return (Annualized) |
|---|---|---|
| Quant Small Cap Fund | Equity | 36.41 % p.a. |
| Canara Robeco Small Cap Fund | Equity | 27.7 % p.a. |
| Edelweiss Small Cap Fund | Equity | 28.62 % p.a. |
| Bank of India Small Cap Fund | Equity | 30.95 % p.a. |
Which small-cap fund is best for 3 years?
Quant Small Cap Fund
The fund from Quant Mutual Fund tops the list with 46.62 per cent returns in the three years. The fund's asset under management (AUM) is Rs 17512.51 crore and the net asset value (NAV) stands at Rs 258.2165. The fund's expense ratio is 0.77 per cent against the category ratio of 0.59 per cent.
| Ticker | Name | 5-year return |
|---|---|---|
| DWAS | Invesco Dorsey Wright SmallCap Momentum ETF | 12.61% |
| OUSM | ALPS O'Shares US Small-Cap Quality Dividend ETF | 10.65% |
| XSMO | Invesco S&P SmallCap Momentum ETF | 10.44% |
| IVOO | Vanguard S&P Mid-Cap 400 ETF | 10.12% |
For an average investor, small-cap funds should not exceed 20-25 per cent of the overall portfolio. In an equity-only portfolio, as per Kochar, around 40-50 per cent can be in large cap, 40-45 per cent in mid-cap and 10 per cent in small-cap funds.
Small-cap stocks are poised for big outperformance in 2024, according to one of Wall Street's biggest bulls. Fundstrat's Tom Lee reiterated his call for the small-cap Russell 2000 RUT to climb 50% in 2024 and top 3,000 for the first time after the index scored its best daily advance in more than a month on Wednesday.
| Stock | Expected Change in Stock Price* |
|---|---|
| Tesla Inc. (TSLA) | 61% |
| Mastercard Inc. (MA) | 14.2% |
| Salesforce Inc. (CRM) | 7.2% |
| Advanced Micro Devices Inc. (AMD) | 11.3% |
