Small cap mutual funds, which focus on investing in the shares of very small enterprises, achieved a remarkable return of over 40.44% in 2023. In July 2024, these small cap funds once again captured the attention of investors, resulting in an inflow of Rs 2,109.20 crore.
Discussions regarding elevated valuations within the small-cap sector, coupled with recent market fluctuations, are leading numerous investors to acknowledge the possibility of an impending correction. Mutual fund managers and financial advisors indicate that while valuations appear high, investors should persist in allocating funds to small-cap schemes for long-term wealth creation. Many mutual fund advisors assert that despite the significant appreciation in the small-cap segment over the past six months, investors can still strategically invest in these schemes in a phased approach to foster wealth accumulation over time.
Small cap schemes focus on investments in very small enterprises or their shares. In accordance with the regulations set forth by Sebi, these schemes are required to allocate funds to companies that are positioned below the 250th rank in terms of market capitalization. Furthermore, they must ensure that at least 65% of their investments are directed towards small cap stocks. Small companies often experience significant fluctuations, more so than their larger counterparts in the large and mid cap categories. Consequently, investing in small cap stocks is regarded as highly risky; this segment can exhibit considerable volatility, particularly in the short term. Therefore, small cap schemes are advised exclusively for aggressive investors who possess a substantial risk tolerance and a long-term investment perspective.
Should invest in small cap funds?
Have you ever considered the reasons behind the willingness of investors to engage in high-risk small cap schemes? These investment options possess the potential to yield substantial returns over an extended duration. For instance, the small cap sector has historically provided an average return of 19% over a decade. Nevertheless, to achieve such impressive returns, one must be ready to endure significant risk and market fluctuations.
Identifying successful entities within the small-cap sector poses significant challenges. A considerable number of these firms remain relatively obscure and lack thorough research coverage. Additionally, their management teams may exhibit questionable ethics, often making exaggerated claims that lack substantiation. In certain instances, management, in collusion with market operators, may artificially inflate stock prices. These factors contribute to the market’s tendency to disproportionately reward or penalize such companies.
Should these companies achieve success, the market will gravitate towards their stocks, resulting in investors experiencing significant gains in their portfolios. Conversely, if they encounter difficulties, the stocks may face substantial declines, potentially rendering them worthless almost overnight.
In summary, investing in small-cap stocks requires careful consideration and is not a simple endeavor. It is essential to identify proficient fund managers who focus on small-cap investments. Additionally, one must evaluate the performance of these funds during periods of market decline.
To build wealth over the long term, consider investing in the following small-cap funds. Stay informed by following our monthly performance updates for these funds. The Axis Small Cap Fund has remained in the third quartile for the past 16 months, having previously spent two months in the fourth quartile. Meanwhile, the SBI Small Cap Fund has consistently occupied the third quartile for the last five months.
Best small cap funds to invest in September 2024:
- Axis Small Cap Fund
- SBI Small Cap Fund
- Kotak Small Cap Fund
- Nippon India Small Cap Fund
Our methodology:
ETMutualFunds has utilized the subsequent criteria for the selection of Equity mutual fund schemes.
1. Mean rolling returns: Rolled daily for the last three years.
2. Consistency in the last three years:
i)The Hurst Exponent, denoted as H, is utilized to assess the consistency of a fund. This exponent serves as an indicator of the randomness present in the Net Asset Value (NAV) series of a fund. Funds characterized by a high H value typically demonstrate lower volatility in comparison to those with a low H value.
When H equals 0.5, the return series is classified as a geometric Brownian time series. Forecasting this type of time series presents significant challenges.
ii) A series is considered to exhibit mean reversion when H is less than 0.5.
iii) Conversely, when H is greater than 0.5, the series is characterized as persistent. A higher value of H indicates a more pronounced trend within the series.
3. Downside risk: For this analysis, we have exclusively focused on the negative returns associated with the mutual fund scheme.
X represents returns that fall below zero.
Y denotes the total of all squared values of X.
Z is calculated as Y divided by the number of days used to compute the ratio.
The downside risk is determined by taking the square root of Z.
4. Outperformance: The evaluation is conducted using Jensen’s Alpha over the past three years. This metric reflects the risk-adjusted return produced by a mutual fund scheme in comparison to the anticipated market return as estimated by the Capital Asset Pricing Model (CAPM). A higher Alpha signifies that the performance of the portfolio has exceeded the returns forecasted by the market.
The average returns generated by the mutual fund scheme can be calculated as follows:
[Risk-Free Rate + Beta of the Mutual Fund Scheme * {(Average return of the index – Risk-Free Rate}].Read More
