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Investing in small-cap funds

Dhirendra Kumar delves into different aspects of small-cap funds from the investment perspective

Should an investor with a time horizon of seven year continue investing in ABSL Small Cap Fund since the fund hasn't performed well in the last two years?
- Gaurav Sarda

Yes, most small-cap funds have not done well in the last two years and more so what happened in the month of March, 2020. Even if they were doing well, those few days during that period would have been enough for any small-cap fund to lose all the gains that it would have accumulated over the last two-three years. So, everything happened in a hurry and nobody could anticipate it. With the extreme vulnerability of smaller companies and changing market weather, these stocks got a massive blow.

I've said it before, a time frame of seven years for a small-cap fund is good. But investing in a small-cap fund is not easy when you see the continuous free fall in them and you are putting your money that is not earning return when other parts of the markets are doing well. The most rewarding small-cap funds end up giving more returns for the patience that you have. So, if you have a strong stomach to withstand all these losses or decline in value or inertia of the fund just not going anywhere for a long period of time, then you can carry on investing in them.

I think small-cap mutual funds do end up adding significant value to the small-cap arena because if you try to invest in small-cap stocks yourself, unless you are very thoughtful and you have a greater understanding, you will end up with a lot of garbage. This is because the Indian market is very broad, very shallow and there are a large number of speculative companies where promoters actually play dirty tricks and a lot of operators function to rig up prices and dump it on individual investors.

Fund managers of small-cap funds provide you with one of two benefits which is very straightforward and it happens by design. One is that you can do your SIP. Averaging your investment is one thing that reduces your risk substantially. Secondly, the diversification itself is very good because in the small-cap fund, the ability to diversify with your small sum of money is very difficult if you do it on your own, as keeping track of 50 small companies for an individual is nearly impossible and it is very tricky. For small companies, you don't have plenty of information to decode and understand and also validate things which a fund manager will be doing a little more rigorously.

Apart from these two things, comes the rigor required for stock picking. When I look at the large-cap funds, I find that about 60 per cent of the portfolio is common across all kinds of funds. When I look at small-cap funds, every fund is different. They have different emphasis, a different portfolio, there is hardly a commonality in their portfolio and hence, they don't look alike. So, there is a glory for small-cap fund managers as they work hard for the reward for being right or lucky with a good small-cap portfolio.

So, yes, if you have a seven years' timeframe, go ahead with a small-cap but it is not meant for all kinds of investors.