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Is it the right time to continue investing in small and mid-cap funds?

  • Akshatha Sajumon
  • 14 Feb
  • 6 minutes

Investment in mutual funds is a relatively safer investment option as compared to the traditional investment in stocks and therefore has a place for every investor category. Among the various categories of mutual funds, small-cap funds and mid-cap funds are considered to be riskier as compared to large-cap funds but also compensate for this risk with higher returns. The onset of the pandemic saw a huge slump in the markets which wiped out the majority of investors in the small-cap and mid-cap segment. However, since then, markets have seen a tremendous boom and the question in every investor’s mind is what is the ideal time to invest in small and mid-cap segments to maximize their wealth.

What are mid-cap funds?

Before investing in mid-cap funds it is important to understand the meaning of this category of funds. Mid-cap funds are mutual funds that invest primarily in mid-cap companies, i.e., companies that are ranked between 101 to 250 in terms of market capitalization. These companies are considered to be relatively riskier than the blue-chip companies or large-cap companies but the returns generated are also relatively higher. 

What are small-cap funds?

This is the final category of mutual funds when classified based on the market capitalization of the companies. Small-cap funds invest predominantly in companies that are ranked beyond 250 in terms of market capitalization. These funds belong to the high-risk high returns category and can be included in the portfolio to boost the overall profitability of the market. 

Who are the target investors?

Volatility on stock markets cannot be ignored and the stocks in every segment react to such volatility in their own capacity. Large-cap stocks are relatively stable and hence, they do not react much to price volatility. This also gives little margin for gains based on speculations. Mid-cap stocks and small-cap stocks are quite volatile their ability and degree of reaction to price fluctuations make it a perfect opportunity to generate higher returns. 

However, this also implies that the funds that invest in these stocks are ideal for investors with a relatively higher risk appetite. Also, these funds may face volatility in the short term but the average period of investment for mid-cap and small-cap funds are 4 to 5 years and 10to 12 years respectively. 

What are the points to consider for investment in small-cap and mid-cap funds?

Small-cap funds and mid-cap funds have seen a tremendous rally in the post-pandemic period. The highs that markets have seen after the initial crash led by the pandemic have made the stocks in these categories make up for the lost ground. However, there are a few points that need to be considered while investing in small-cap and mid-cap funds. Some of these factors are mentioned below.

  1. Investment in small-cap and mid-cap funds lacks the liquidity of large-cap funds hence, it may make a timely exit from the markets difficult. 
  2. The potential for growth in these funds is higher as compared to the large-cap fund segment. 
  3. The risks of the small-cap and mid-cap funds include the inherent risks, risk of market fluctuations which can eliminate the potential of earning higher returns from this category of funds.
  4. It is important to stay invested for a longer duration to maximize the gains for any investor in small-cap and mid-cap funds. Short-term volatility may drain the gains in this category but equities are known to bounce back in the long run and at such times, small-cap and mid-cap funds help in maximizing the overall wealth of the portfolio.

Is investment in small-cap and mid-cap favourable?

The markets have recently seen one of their biggest falls small-cap funds and mid-cap funds are some of the majorly hit areas due to their tendency to react in extreme to the market volatility. That said, it is also important to note that the post-pandemic period has seen some of the major recoveries in these segments. This is backed by various reasons like the government support to the MSME sectors, the relief packages announced in the face of Covid 19, the favourable market sentiment. 

While small-cap and mid-cap funds can be attractive investment options, it is imperative that investors have a balanced equity portfolio based on your risk appetite. Investors should also focus on quality funds from the small-cap and mid-cap category which invest in top companies in these segments. 

Having a long-term approach to small-cap and mid-cap funds is crucial to having a successful portfolio along with ignoring the noise of short-term volatility. If the objective of the fund and the risk-reward parameters of the fund matches that of the investors, small-cap funds and mid-cap funds are an excellent addition, or as most experts believe, a crucial part of every portfolio. 

Conclusion

There is no ideal time of investment for small-cap funds or mid-cap funds. For that matter, there is no ideal time of investment for any security in the stock markets. What matters the most is the time spent investment or the total time period of the investment in these funds to maximize the investor’s wealth. The longer the duration of investment, the higher the benefit of compounding is the golden rule of investment in stock markets. This rule is especially true in the case of small-cap and mid-cap funds. 

FAQs

What is the average returns posted by small-cap funds in the past year?

Post recovery of the markets from the pandemic, small-cap funds have rallied the most and the returns generated by some of the top funds in this category are close or 60% approximately in the year 2021. S&P BSE 250 SmallCap TRI benchmark offered around 56% returns in the year

What is the ideal investment horizon for mid-cap funds?

The ideal investment horizon for mid-cap funds is anywhere between 4 years to 6 years.

What is the minimum amount of investment needed to qualify for mid-cap funds or small-cap funds?

The minimum amount of investment needed to qualify for mid-cap funds or small-cap funds is 65% in mid-cap companies and small-cap companies respectively.

 What is the benefit of investing in small-cap and mid-cap funds through SIPs?

SIPs are the ideal way of investment in mutual funds as it does not require huge capital investment and can reduce the overall cost of investment. At the same time, the benefit of compounding is also available to investors. A small-cap fund or a mid-cap fund may provide negative returns in the short term but with the benefit of compounding in the long term, the same fund can provide decent returns that are usually higher than any large-cap fund.

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Akshatha Sajumon

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