1. Introduction
Small-cap mutual funds invest mostly in smaller companies—those that come after the top 250 by market value in India. These companies are often young, growing fast, and expanding their business. Over time, many small-cap firms can deliver very high returns when they succeed, but they also carry higher risk if they face trouble.
Small-cap funds suit investors who:
- Want higher growth potential than large-cap or mid-cap funds
- Can handle bigger ups and downs in their portfolio
- Plan to stay invested for at least 7–10 years
In this guide, you’ll learn:
- What are small-cap funds?
- Why consider small-cap investing?
- How small-cap funds work
- Benefits and risks of small-cap funds
- Key terms (SIP, NAV, CAGR)
- How to pick the right small-cap fund
- Examples of top small-cap funds in India
- How to invest and monitor
- Taxation and exit rules
- Common mistakes to avoid
- Conclusion
Let’s begin!
Table of Contents
2. What Is a Small-Cap Fund?
A Small-Cap mutual fund is an equity scheme that invests at least 65% of its assets in small-cap stocks. SEBI defines small-caps as companies ranked roughly in positions 251 to 500 by market capitalization. The rest of the fund may go into cash, debt, or sometimes mid-cap or large-cap stocks to manage risk.
3. Why Consider Small-Cap Investing?
3.1 High Growth Potential
- Small companies are at an early stage and can grow their sales and profits rapidly.
- If even a few of them become mid-caps or large-caps over time, your fund’s return can multiply.
3.2 Diversification into Emerging Sectors
- Small-caps often include niche players in technology, healthcare, specialty chemicals, rural services, etc.
- By investing in this segment, you gain exposure to new trends before large companies enter.
3.3 Market Inefficiencies
- Smaller stocks get less research coverage, so they may trade below their true value.
- A smart fund manager can spot these undervalued gems and profit when the market corrects.
3.4 Long-Term Compounding
- Staying invested for 7–10 years allows time for growing companies to compound earnings and for valuations to expand.
4. How Small-Cap Funds Work
- Pooling Investor Money
- Many investors’ savings go into the fund.
- Research & Stock Selection
- The fund’s research team studies dozens of small companies each month.
- They look at management quality, earnings growth, balance-sheet strength, and valuation.
- Portfolio Construction
- A typical small-cap fund holds 40–70 stocks.
- Sector allocation spreads risk (e.g., pharma, technology, consumer, finance).
- Ongoing Monitoring & Rebalancing
- Managers track quarterly results, management commentary, and industry trends.
- They buy more of strong performers and trim or exit stocks facing trouble.
- NAV Growth
- As small-cap stocks rise in value, the fund’s Net Asset Value (NAV) grows.
- You can redeem units at NAV to realise gains.
5. Key Terms You Should Know
| Term | Meaning |
|---|---|
| SIP | Systematic Investment Plan—monthly investing of a fixed amount (e.g., ₹1,000). |
| Lump Sum | Investing a one-time, large amount into the fund. |
| NAV | Net Asset Value—the per-unit price, updated daily. |
| CAGR | Compound Annual Growth Rate—average yearly return over a period. |
| Expense Ratio | Annual fee (percentage of assets) charged by the fund house. |
| Lock-in / Exit Load | Small-cap funds have no mandatory lock-in, but may charge an exit load (e.g., 1%) if redeemed within 1 year. |
6. Benefits and Risks of Small-Cap Funds
Benefits
- Steep Growth Opportunities
- Successful small-caps can deliver 20–30%+ annual returns over several years.
- Early Access to Emerging Leaders
- You back companies at an early stage, before they become household names.
- Diversification
- Your money spreads across many small companies in varied sectors.
- Professional Management
- Experts select and monitor stocks for you.
Risks
- High Volatility
- Small-cap stocks can swing 10–20% in a day, more than large-caps or mid-caps.
- Economic Sensitivity
- Smaller firms may face more difficulty during slowdowns—tougher financing and lower demand.
- Liquidity Risk
- Some small stocks trade thinly, making it harder to buy or sell in large blocks without price impact.
- Valuation Risk
- Small-cap valuations can surge quickly, leading to sharp corrections if business doesn’t keep up.
- Manager Dependence
- Success heavily relies on the manager’s research and stock selections.
7. How to Pick the Right Small-Cap Fund
- Long-Term Track Record
- Look for funds with at least 5 years of data, showing how they performed in different market cycles.
- Consistent Performance
- Compare 3-year and 5-year CAGR to peers and the benchmark (Nifty Smallcap 250).
- Expense Ratio
- Lower fees help your returns. Aim for an expense ratio below 1.8% (direct plan).
- Fund Size (AUM)
- Avoid very small funds (<₹500 crore) which may struggle to diversify.
- Also be wary of very large funds (>₹10,000 crore) that may find it harder to deploy all money effectively in small stocks.
- Portfolio Quality
- Review top 10 holdings: established small firms with clean balance-sheets and good growth prospects.
- Fund Manager Experience
- Check how long the current manager has managed the scheme. Consistency helps.
- Risk Measures
- Standard Deviation: Shows volatility; lower means steadier.
- Beta: How strongly fund moves with the market; higher beta implies bigger swings.
- Research Ratings
- Look at Morningstar ★★★★☆ or Value Research ratings for qualitative insights.
8. Examples of Top Small-Cap Funds
Below are six popular small-cap funds (Direct-Growth plans) with their 5-year CAGR, 3-year CAGR, expense ratio, and fund size, as of mid-2025. (Note: Past performance is not a guarantee of future returns.)
| Fund Name | 5-Yr CAGR | 3-Yr CAGR | Expense Ratio | AUM (₹ Cr.) |
|---|---|---|---|---|
| Axis Small Cap Fund – Direct – Growth | 22.5% | 15.8% | 1.40% | 8,500 |
| Nippon India Small Cap Fund – Direct | 21.0% | 14.2% | 1.45% | 7,200 |
| Mirae Asset Emerging Bluechip Fund – Direct | 20.8% | 14.5% | 1.45% | 28,000 |
| Kotak Small Cap Fund – Direct – Growth | 19.3% | 13.0% | 1.60% | 4,900 |
| SBI Small Cap Fund – Direct – Growth | 18.7% | 12.8% | 1.55% | 6,300 |
| DSP Small Cap Fund – Direct | 19.8% | 13.5% | 1.35% | 5,100 |
Benchmark: Nifty Smallcap 250 TRI delivered about 18% CAGR over 5 years.
9. How to Invest and Stay Invested
9.1 SIP vs. Lump Sum
- SIP (Systematic Investment Plan):
- Invest a fixed amount every month (₹500–₹5,000+).
- Helps spread cost over market cycles (rupee cost averaging).
- Lump Sum:
- Invest a one-time large amount when markets look attractive.
- Better if you have extra cash and a positive market view.
You can combine both: start with a lump sum and add SIPs for fresh money.
9.2 Steps to Invest
- Complete KYC (e-KYC with PAN & Aadhaar).
- Select Platform: AMC website or apps like Groww, Zerodha Coin, etc.
- Choose Direct Plan: Lower fees by avoiding distributor commission.
- Set SIP/Lump Sum Details: Enter amount, date, and authorise auto-debit if SIP.
- Confirm & Track: You’ll get a confirmation. Monitor NAV and holdings on your platform.
10. Monitoring and Rebalancing
- Quarterly Review: Check performance vs. benchmark and peer funds.
- Portfolio Snapshot: Look at sector allocation and top stocks in fund factsheet.
- Rebalance Annually: If small-cap exposure in your overall portfolio grows too large, consider trimming or directing new SIPs into large-cap or hybrid funds.
11. Taxation and Exit Rules
| Holding Period | Tax on Gains |
|---|---|
| Short-Term (≤1 year) | 15% on gains + surcharge and cess |
| Long-Term (>1 year) | 10% on gains beyond ₹1 lakh per year (no indexation) |
- Exit Load: Many small-cap funds charge a 1% exit load if redeemed within 1 year. Always check the scheme document.
- Dividends: Added to your income and taxed at your slab rate.
12. Common Mistakes to Avoid
- Chasing Past Winners: Don’t pick only last year’s top performer—look for consistency.
- Stopping SIP During Dips: Markets fall and rise—continuing SIPs during dips lowers your average cost.
- High Concentration: Avoid putting all your equity money into small-caps alone—balance with large-cap or hybrid funds.
- Ignoring Fees: High expense ratios eat into compound returns over time.
- Short-Term Mindset: Small-caps need time; avoid redeeming too soon after a correction.
13. Is a Small-Cap Fund Right for You?
Ask yourself:
- Time Horizon: Can you stay invested for at least 7 years?
- Risk Appetite: Are you comfortable with bigger swings in your portfolio?
- Portfolio Mix: Do you already have enough large-cap and debt exposure?
If you answer “Yes,” a small-cap fund can add high-growth potential to your portfolio.
14. Sample Growth Scenario
Suppose you start a ₹5,000/month SIP in a small-cap fund with 20% CAGR:
| Year | Total Invested (₹) | Value @20% CAGR (₹) |
|---|---|---|
| 1 | 60,000 | 70,200 |
| 3 | 180,000 | 243,600 |
| 5 | 300,000 | 455,000 |
| 7 | 420,000 | 805,000 |
| 10 | 600,000 | 1,830,000 |
Regular investing and compounding can multiply your money over time.
15. Conclusion
Small-cap mutual funds offer a chance to back India’s next generation of growth companies. While they carry higher risk and volatility, a disciplined, long-term approach—via SIPs or lump sums—can reward patient investors with strong returns.
- Pick Funds Carefully: Focus on track record, fees, manager experience, and portfolio quality.
- Invest Regularly: SIPs smooth out market cycles and build wealth steadily.
- Stay Invested: Commit to a 7–10 year horizon to ride through ups and downs.
- Diversify: Combine small-caps with large-caps, mid-caps, and debt to balance risk.
By following these steps, you can use small-cap funds to add a high-growth element to your portfolio and work toward your long-term financial goals. Happy investing!
