Fears of an asset bubble in small-cap stocks: Stagger investments in small-cap funds

financialexpress.com:

With several fund houses restricting investments in their small-cap funds and the markets regulator also now expressing concerns over frothy valuations, individuals must exercise caution. They should opt for systematic investment plans (SIPs) and avoid lumpsum investments in this segment, say experts.

Before investing in small-cap funds, investors must note the fund size. If it is too large, then generating alpha would be difficult. Individuals should stay invested for over five years to earn higher returns. And the return expectations need to be around long-term averages and not what the market has delivered over the past one year.

Taking a cue from the markets regulator, Association of Mutual Funds in India has directed fund houses to find ways to protect the interest of small-cap investors in a frothy market. As the small-cap segment is in an overbought zone, fund managers are finding fewer reasonable opportunities to invest in. The assets under management of small-cap schemes rose 89% to Rs 2.48 trillion in January from Rs 1.31 trillion in the same period last year.

In July 2023, Nippon India Mutual Fund and Tata Mutual Fund stopped accepting lumpsum investments in their small-cap funds. Last week, Kotak Mahindra Mutual Fund  restricted lumpsum investments. Given the inherent volatility and lower liquidity of small-cap stocks, the imposition of restrictions underscores the importance for both existing and new investors to proceed with caution.

Nirav Karkera, head, Research, Fisdom, says investors need to assess their risk tolerance, investment horizon and financial objectives before venturing into small-cap investments beyond a certain threshold. “Prudent decision-making and meticulous risk assessment are essential