How much should you allocate to smallcap funds in your portfolio?

The shift in the investment behaviour of the Indians, along with multiple categories of mutual fund offers by asset management companies, resulted in the launching of a wide bouquet of funds based on market capitalisation, risk-based, theme-based, and many more. Traditionally based on market capitalisation, funds are defined as large-cap, mid-cap and small-cap. 10

What are market capitalisation and small-cap funds?

Market capitalisation is the present market value of shares multiplied by the company’s total number of outstanding shares. Small-cap funds are open-ended mutual funds, which invest 65% of their investments in companies that rank below 250th in terms of market capitalisation. Investors whose risk appetite is very high may invest a small part of their portfolio but for a long-term horizon, like 5 years or more.

Some of the notable small cap funds launched more than ten years back, on 01-01-2013, have an AUM of more than Rs.30,000 crore and return more than 25%, and are Nippon India Small Cap and SBI Small Cap Fund.

How much should you invest in small-cap funds?

To answer this question, you need to know that there’s no universal rule for how much to invest in small-cap funds; it depends on your individual asset allocation needs. Generally, a 60% equity and 40% debt strategy is a sound approach for most investors.

Within the 60% equity portion, you should opt for at most 15-20 % allocation to small-cap funds, while the rest 40% in mid and large-cap funds. You need to keep rebalancing your portfolio regularly to ensure you do not increase your exposure to small-cap funds, as they are more volatile in nature. For aggressive investors, the allocation can at max go upto 30% but not beyond, as it would increase the overall risk of the portfolio.

Let’s understand in detail.

If we take stock after 15 years of Lehman Brothers’ fall in 2008, we notice that the SENSEX fell around 30% from August to October 2008, but the BSE Mid Cap Index and BSE Small Cap Index fell by 45%. The year 2009 witnessed a reverse trend: the small-cap index returned 115 %, and the mid-cap index gained almost 100%. On the contrary, the SENSEX only provided an absolute return of 75.30 %.

In the last 1 year, the best small cap returned 75 %, whereas the worst returned 41.40 %, and large-cap NIFTY 50 returned only 24.01 %. Investors with a long-term vision and high-risk appetite can have a small part of the entire portfolio in small caps to maximise the overall portfolio returns. However, you need to keep in mind that the liquidity in the small-cap is also a concern in certain cases.

Thus, there is no ideal ratio or percentage calculation that may be allotted to small-cap funds. It completely depends on the investor’s asset allocation requirement coupled with financial goals and risk appetite. However, as per the thumb rule, 10-20 % may be allocated for the small-cap as funds like SBI Small Cap fund or Nippon India Small Cap fund have produced a return of more than 27 % CAGR growth in the last 10 years.

Note: Another important aspect that needs to be remembered is that 10-20 % exposure is inclusive of all categories. It means if an investor has a flexi cap fund and small-cap exposure exists in it, that one also must be taken into consideration for the calculation of small-cap exposure.

A brief synopsis of the top 5 small-cap funds in India

To understand the returns of funds managed by AMCs, we have sorted the funds based on the highest AUM(Assets under management) first and then by 10 years’ return.

1. Nippon India Small Cap Fund -The fund is more than 10 years old with an AUM of Rs. 56,468.75 crore, and the return is 26%.  The equity holding is 95.91%, out of which large-cap investments are 6.01%, mid-cap investments are 11.36%, small-cap investments are 54.13%, and others are 24.41%.
   
2. SBI Small Cap Fund – This is more than 10 years old AUM is Rs. 30,835.87 crore, and the return is 26 % in the last 10 years. The equity holding is 87.34%, out of which the large-cap investments are 0%, mid-cap investments are 10.68%, small-cap investments are 45.85%, and others are 30.81%.
   
3. HDFC Small Cap Fund -This is more than 10 years old. AUM is Rs. 31522.66 crore, and the return has been 22% in the last 10 years. The equity holding is 92.62%, of which the large-cap investments are 3.74%, mid-cap investments are 3.59%, small-cap investments are 68.60%, and others are 16.69%.
   
4. Quant Small Cap Fund –  This is also a more than 10-year-old small cap fund with an AUM of Rs.22,967.17 crore and a return of 22%. The equity holding is 98.15%, out of which large-cap investments are 12.27%, mid-cap investments are  9.92%, small-cap investments are 39.65%, and others are 3.31%.
   
5. Axis Small Cap Fund – This is another,  more than 10-year-old small cap fund with an AUM of Rs.22,262.42 crore, and the return is 23%. The equity holding is  92.77%, out of which large-cap investments are 2.79%, mid-cap investments are 3.97%, small-cap investments are 56.24%, and others are  31.58%.

But why should you invest in small-cap funds at all? Let’s understand in detail.

Conclusion

Understanding market capitalisation coupled with patience plays an important role in an investment decision. When large-cap funds are not doing well, small and mid-cap funds may perform well, so it is important that the portfolio of an investor preferably has funds of diversified categories like large-cap, mid-cap, and small-cap. 

References

1. https://www.shareindia.com/knowledge-center/mutual-fund/understanding-small-cap-mid-cap-and-large-cap-funds
2. https://www.shareindia.com/knowledge-center/mutual-fund/understanding-small-cap-mid-cap-and-large-cap-funds
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4. https://www.livemint.com/Money/QdLyoKEY5uVUtf373CSSYI/Money-management-investment-lessons-from-2008-global-crisis.html
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