Going bananas over small- and mid-cap funds

It's all wine and flowers for small- and mid-cap funds right now - and deservedly so. They swelled their investors' wealth by 28 per cent and 24.8 per cent, respectively, in just the last 12 months. To give you perspective, the Sensex gained 21.37 per cent during the same time.

Since strong performances attract investors like bees to honey, more than Rs 15,000 crore investment money has been pumped into these funds in the last three months alone. To be precise, Rs 10,810 crore into small-cap funds and Rs 4,770 crore in mid-cap funds.

The gush of money has been so strong that two small-cap funds - Tata Small Cap Fund and Nippon India Small Cap Fund - have stopped accepting lumpsum investments, with the latter stating: "The step is warranted considering the recent sharp rally in the small-cap space and increased investor participation through high ticket investments, which would be in the best interest of existing unit holders and appropriate for incremental investments."

While these two mutual fund categories bask in the glory and grapple with the problem of plenty, flexi-cap, large-cap, and tax-saving funds find themselves sulking in the corner. Perhaps, it is envy because the trio saw a combined net outflow of over Rs 5,000 crore between April and June.

What you should do
When it comes to small-cap funds, beware of what happens after a blockbuster year.

For example, the average small-cap fund returns in 2014 were around 87 per cent, followed by 10.32 per cent and 5.18 per cent in 2015 and 2016, respectively. Again in 2017, the small-cap funds gave returns of 54.54 per cent. But that was followed by negative returns in 2018 (-18.71 per cent) and 2019 (-1.47 per cent). Likewise in 2022, small-cap funds were in the red after giving returns of 63.13 per cent in 2021 and 30.52 per cent in 2020.

While we aren't predicting 2024 to reverse the fortunes of small- and mid-cap funds, we simply urge you to stay cautious. Only invest in small- and mid-cap funds if you have at least a five-year time horizon.

Last but not least, we'd suggest you invest only up to 20 per cent of your money in small- and mid-cap funds. Because, to borrow Warren Buffett's words, "Be fearful when others are greedy."

Suggested read: Small-cap funds: High on cash, low on ideas