Mutual Funds, SIP investment tips: Keep these factors in mind while selecting a small cap product

Mutual funds investment tips: If you are planning to invest in small cap funds, here are few factors you must consider before putting the money.

These funds have high return potential but come with great risk at the same time. Source - Reuters.

Systematic Investment Plan or SIP - offered by Mutual Funds - has become a highly popular investment method in India. According to the latest data released by Association of Mutual Funds in India in December 2018, Indian Mutual Funds have currently about 2.54 crore (25.4 million) SIP accounts through which investors regularly invest in schemes. The data shows that MF industry has added about 9.46 lakhs SIP accounts each month on an average during the FY 2018-19, with an average SIP size of about Rs 3,150 per SIP account. For the ambitious-young-India small caps are the preferred investment option. These small cap funds invest in stocks of smaller-sized companies. Even though the definition of small cap can vary, these are generally companies with a market capitalization of less than Rs 100 crores. These funds have high return potential but come with great risk at the same time.

Should you invest in small cap funds?

Registered Investment Advisor, Harsh Roongta believes that it is more important to decide if an investor wants to opt for small cap funds than to decide which fund to invest in. He added that the amount to be invested in these products should also be pre-defined.

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"The riskiest part of your allocation goes towards small cap funds. The amount that an investor plans to put in a small cap fund has to be pre-defined. It is far more important to decide if you want to invest in small cap fund than selecting which fund you want to invest in. These funds, by the very definition, are extremely volatile. No matter how successful it has become, a small fund that has grown to Rs 3000 crore or Rs 4000 crore, will become tough to sustain. The investors should think twice before going to a very large small cap fund," Roongta told Zee Business Online.

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He explained that the liquidity of small cap funds is also very poor. This means that the investors may not be able to withdraw the money easily.

Factors to keep in mind while choosing funds:

Certified Financial Planner, Poonam Rungta told Zee Business Online that any investor putting money in small cap funds should know that it is a very aggressive category. She said that it is very important to keep a long time horizon of at least 10 years. "Small Cap funds are very aggressive and volatile. To invest in these, you need to have a long term goal. Then, only small caps will deliver the kind of returns investors are looking at," she said.

Rungta explained that as the the name suggests, the fund manager invests in very small companies that have less market size and are starting to grow. So, they may or may not grow, making these funds very risky.

If you are planning to invest in small cap funds, here are few factors you must consider before putting the money:-

1. Closely monitor performance: Due to their volatile nature, small cap funds tend to fluctuate a lot. This is why the the investors need to keep a close eye on their performance. "The investors should look whether the fund has given good returns historically or not," Rungta said. "A layman would always look at historic return. If normal investors would look at Alpha or P-ratio, they won't understand anything. They should also look at fund manager and the performance of his other funds," she added.

2. Only make it a part of portfolio: Since the small cap funds come with high risk, it is important to ensure that not all the money is invested in them. "It is important to ensure that small cap funds are a part of the portfolio, not the entire portfolio. If an investor is very aggressive and puts all the money in small cap funds, it would be wrong," Rungta said.

3. Fund manager: Unlike large or mid cap funds, the fund managers have more room to man-oeuvre with small cap funds. So, it is important to understand their past performance. Rungta advised that investors should also check the performance of other funds managed by the same manager to get a better understanding.

Final verdict:

While the small cap funds come with an attractive interest rate, investors should know every aspect before putting their money in this product due to the risk involved. Harsh Roongta believes that it doesn't make sense to take direct small cap exposure. Instead, investors should opt for it through a mid-cap fund.

"An exclusive small cap fund doesn't make sense. The investors should rather take their small cap exposure through a mid cap fund. That too, with a fun manager or fund company with which they have faith," he said.

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