Invest in Top Smallcap Mutual Funds In 2022: High Return Mutual Funds In India
Some investors have a conservative risk profile. Hence, for the equity portion of their portfolio, they prefer to stick to active large-cap funds or Nifty 50 Index funds. However, investors with an aggressive risk profile can consider investing in mid and small-cap funds. Small-cap funds have the potential to deliver high returns but come with very high risks. This article discusses how to invest in top smallcap mutual funds in 2022.
What is a small cap fund?
Before talking about small-cap funds, let us understand small-cap stocks. As per SEBI guidelines, the top 251st company onwards in terms of market capitalisation are known as small-cap companies. These companies are a part of the Nifty Smallcap 250 Index.
Now that we understand small-cap companies, let us discuss small-cap mutual funds. A small-cap mutual fund is an open-ended equity scheme that predominantly invests in small-cap stocks. An active small-cap mutual fund has to invest a minimum of 65% of its total assets in equity and equity-related instruments of small-cap companies.
A small cap index fund has to invest a minimum of 95% of its total assets in the securities of the index (Nifty Smallcap 250 Index in case of most small-cap index funds) that it is replicating or tracking.
Returns given by the best small-cap mutual funds
Let us look at the returns given by some of the top small cap mutual funds.
(Direct Plan - Growth option)
|Axis Small Cap Fund||8,410||42.88%||34.98%||22.66%|
|Nippon India Small Cap Fund||18,933||46.09%||33.55%||22.07%|
|Kotak Small Cap Fund||6,810||41.13%||37.84%||21.28%|
|HDFC Small Cap Fund||13,523||37.17%||23.11%||19.26%|
|L&T Emerging Businesses Fund||8,166||51.01%||26.38%||18.39%|
The above table shows the best small-cap fund has given returns of 22.66% CAGR in the last five years.
Who should invest in small-cap mutual funds?
Please note that all equity funds are risky, as equity markets, by nature, are risky and volatile. However, smallcap funds carry a higher risk than large-cap and mid-cap funds. In proportion to the high risk they carry, small-cap funds have the potential to give higher returns than mid-cap and large-cap funds. So, if individuals are willing to take risks higher than large-cap and mid-cap funds, you can consider investing in small-cap funds.
Taxation of small-cap funds
For taxation purposes, small-cap mutual fund schemes are treated as equity schemes and taxed accordingly.
- Short-term capital gains (STCG) tax: If you sell your smallcap mutual fund scheme units within twelve months of purchase, the capital gain will be classified as short-term capital gain (STCG). The short-term capital gain (STCG) tax will be levied at 15%.
- Long-term capital gains (LTCG) tax: If you sell your small-cap mutual fund scheme units after twelve months of purchase, the capital gain will be classified as long-term capital gain (LTCG). Every financial year, the first Rs. 1 lakh long-term capital gain will be exempt from taxation. The incremental long-term capital gain above Rs. 1 lakh will be taxed at 10%.
Risks involved in small-cap mutual funds
Small-cap mutual funds carry high risk. When the market sentiment is bad during uncertain events, the entire stock market may see a brutal sell-off. Small-cap mutual funds may also see a sharp drop in their net asset value (NAV) during such times.
The above chart shows how the Nifty Smallcap 250 Index experienced a sharp sell-off during 2008-09. In 2018 also, the index started a long correction phase that continued in 2019 and was finally aggravated further by the Covid pandemic in early 2020. The small-cap index has its cycles of ups and downs. If you invest at the start of a correction phase, you risk facing losses till the correction ends and the growth phase starts.
Return potential of small-cap mutual funds
Small-cap mutual funds have the potential to give inflation-beating high returns to their investors. Small-cap companies have the potential to grow faster than large and mid-cap companies. Small-cap companies also have the potential to become tomorrow's mid-caps and then large-caps. Hence, small-cap mutual funds have the potential to create a lot of wealth for their investors, similar to what they have done in the past. Small-cap mutual funds can benefit from the power of compounding and generate good returns for investors.
The above chart shows that the Nifty Smallcap 250 Index had a base value of 1,000 in April 2005. As of 31st Jan 2022, the index trades around 10,000. Thus, in the sixteen years, the index has compounded investor wealth by around ten times, which is a very good growth rate.
In the table in the earlier section, we have seen how the best small cap mutual fund has given returns of 22.66% CAGR in the last five years. It is an excellent return, and very few asset classes can give this kind of return over five years.
Advantages of investing in small-cap mutual funds
The biggest advantage of investing in small-cap mutual funds is their potential to create wealth in the long run that helps fulfil financial goals. Small-cap mutual funds usually fall more than mid and large-cap mutual funds when the sentiment is bad during an overall equity market fall. When the sentiment turns positive and overall equity markets recover, small-cap funds recover their losses and, in the long run, create wealth for their investors
Reasons to invest in small-cap mutual funds
The biggest reason to invest in small-cap mutual funds is that they give you an opportunity to participate in the growth story of some of India's fastest-growing companies. Since these are small-sized companies, they can continue to keep growing faster for the foreseeable future before they reach maturity, unlike large and mid-cap companies. During this excellent growth phase, they have the potential to deliver excellent returns to their investors.
Asset allocation: Invest in small-cap funds along with large and mid-cap funds
As part of your asset allocation strategy, you should not have a concentration of small-cap mutual funds in your investment portfolio. You should diversify your risk by having exposure to large and mid-cap mutual funds along with small-cap funds. However, if you are young and have an aggressive risk profile, you can allocate a higher portion of your investment portfolio to small-cap mutual funds.
To start investing in small-cap mutual fund schemes as per your appropriate asset allocation, download the Glide Invest App from Google Play Store or Apple App Store and get started.
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