Since the criteria to consider a stock as small cap for mutual funds has been precisely defined by SEBI, does it mean that the investment in small cap funds will now be safer than they were in the past?
-Nagesh
No, not really. Earlier, it was very loosely defined. Everybody had their own definition. Now, according to the definition of small cap is a company which is not in the top 250 companies. But that does not reduce the risk. Smallcaps are volatile and risky. And if a fund manager chooses to invest in riskier smallcaps, they will be more volatile.
As I said earlier, you will have a uniform definition of small cap being followed by all funds. Nothing beyond that. That does not make it safer. Smallcaps and midcaps will remain more volatile. You will see big ups and downs.
Small companies, when they turn bigger, will make you a lot of money. And the peril of smallcap is that many companies falter. They don't turn big. They disappear. They don't really make it to the top. So selectivity will work but that does not make it safer. Yes, comparability of smallcap funds will be easier because of the uniform definition.
This article was originally published on August 10, 2018.
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