When it comes to mutual fund investing, most investors tend to stick with large-cap or blue-chip stocks. These are familiar, relatively stable, and backed by big names. But in doing so, they often overlook one category that has the potential to generate exceptional returns over the long term: small-cap funds.
Small cap funds are mutual funds that invest in companies ranked beyond the top 250 by market capitalization and are typically young, high-growth businesses with massive long-term potential.
If you’re ignoring small cap funds, you could be missing out on multiple opportunities, not just in terms of returns, but also diversification, growth, and wealth creation. In this article, we will understand what you stand to lose if you don’t consider small cap funds as part of your investment strategy.
1. Wealth Creation Over the Long Term
If you’re investing with a long-term horizon (say 7-10 years or more), small cap funds can significantly contribute to wealth creation. While they may come with short-term volatility, over time, the growth compounding effect becomes visible.
Some of the most successful Indian stocks started out in the small cap space. Investors who held on to their positions through a small cap fund often reaped the benefits as those businesses scaled up. Skipping small cap investments could mean you’re missing a key piece of the long-term wealth-building puzzle.
2. Diversification Benefits
Most Indian investors tend to have a portfolio that is skewed toward large-cap or mid-cap funds. Adding small cap funds to your mix offers valuable diversification.
Small cap stocks often operate in niche segments and have different growth triggers compared to large caps. Their performance isn’t always aligned with the broader market. So, during certain periods, small caps can outperform while other segments lag.
This non-correlation adds a layer of resilience to your portfolio. By avoiding small caps, you are limiting your exposure to this diverse universe of emerging companies.
3. Scope for Attractive Returns
When you invest in small cap funds, you’re tapping into companies that are still in their early growth stages. These businesses often operate in emerging sectors and have the potential to scale up. That means more room for innovation, profit growth, and sharper stock price appreciation.
For aggressive long-term growth, small caps can outperform their large-cap peers. For example, the Nippon India Small Cap Fund has delivered around 39% annualized returns over the last 5 years.
4. First-Mover Advantage
One of the biggest advantages of investing in good small cap funds is the ability to ride the journey of a company early in its life cycle. Think of it like discovering a great business before the rest of the market notices.
Professional fund managers constantly scout for such hidden gems: companies that are fundamentally strong but still flying under the radar. By getting in early, small cap funds can benefit from the value unlocking that happens as these businesses grow and gain recognition. Missing out on small cap funds could mean missing out on this early entry advantage.
5. Better Recovery After Market Corrections
Interestingly, while small cap stocks tend to fall harder during a market correction, they also tend to bounce back faster and stronger when the market recovers.
This is because small caps often get excessively beaten down during panic-driven sell-offs. But as the sentiment improves and fundamentals reassert themselves, they often become the fastest-growing part of the market.
Conclusion
Small cap funds may come with higher short-term volatility, but their long-term growth potential is hard to ignore. By staying invested with discipline, you can benefit from the rise of tomorrow’s market leaders. If you’re not exploring this space yet, you might be missing a powerful engine for wealth creation.
