Looking to Invest in Small-Cap Funds? Here’s What You Need to Know
Small-cap funds have always intrigued investors with their potential for high returns. However, this comes with significant risks, especially during market corrections. Here’s a detailed look at what you should keep in mind when considering small-cap funds, especially in volatile times.
Recent Performance: A Volatile Category
Small-cap funds have faced the steepest corrections among diversified equity funds in recent months. In October 2024, the category saw an average decline of around 7%, compared to 6.5% in mid-cap funds and 6% in large-cap funds.
The overall market witnessed sharp corrections, with the BSE Sensex and NSE Nifty falling by 5.77% and 6.22%, respectively. Data from the Association of Mutual Funds in India (AMFI) revealed that small-cap funds were particularly impacted, with asset quality taking a noticeable hit during this downturn.
Understanding Liquidity and Risk in Small-Cap Funds
One of the key risks in small-cap funds is liquidity. When markets plummet, investors often withdraw their money, potentially leading to illiquid schemes freezing redemptions, which can further spread panic.
According to October 2024 stress test results:
The top 15 small-cap funds would require an average of 25 days to liquidate 50% of their portfolios, compared to 22 days in September.
Nippon India Small Cap Fund’s liquidation time increased from 26 days to 31 days, with its cash allocation rising from 4.06% to 5.31%.
SBI Small Cap Fund now needs 56 days (up from 46 days) to redeem half its portfolio.
Quant Small Cap Fund’s cash allocation fell from 13.06% to 11.15%, and its liquidation time stood at 55 days.
Liquidity is a vital metric that fund managers monitor closely, especially during market downturns, to ensure they can meet redemption demands.
Risk Management Strategies
Fund managers use a mix of strategies to safeguard investors’ interests and mitigate risks:
1. Diversification: Small-cap funds often invest across multiple sectors and may include mid-cap and large-cap stocks to balance risk.
2. Liquid Holdings: A portion of assets is kept in cash or short-term debt instruments to handle redemption pressures.
3. Advanced Tools: Strategies like stop-loss orders, hedging, and derivatives are employed to manage downside risks.
“Experienced fund managers play a crucial role in navigating market volatility,” says Viral Bhatt, founder of Money Mantra.
How to Invest in Small-Cap Funds
For long-term investors, market corrections can present an opportunity to invest in small-cap funds. Here’s how you can approach it:
1. Systematic Investment Plan (SIP)
Investing a fixed amount regularly via SIPs is a great way to mitigate volatility. It allows you to accumulate more units during market dips and fewer during peaks, lowering your average cost over time.
2. Gradual Investment
Avoid lump-sum investments during uncertain times. Instead, stagger your investments in tranches to reduce the impact of market fluctuations.
3. Focus on Quality
Prioritize funds with a strong track record and quality small-cap stock portfolios. Experienced fund managers with proven expertise are key to selecting funds that can weather market downturns.
Final Thoughts
Investing in small-cap funds requires patience, discipline, and a long-term perspective. While they can deliver impressive returns, the risks are equally significant. By diversifying, staying invested through SIPs, and selecting funds with robust management, you can make the most of these opportunities while minimizing potential pitfalls.
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