Retail investors should temper their infatuation with small caps
₹15,108 crore between April and July this year. Small cap MFs largely invest in small cap stocks. These are stocks that rank beyond the top 250 in terms of market capitalization.
The interesting thing is that the net inflow into small cap equity MFs forms a significant portion of the net investment of ₹25,984 crore in equity MFs during that period. There are several points that arise here. First, net investment in small cap MFs forms around three-fifths of the overall investment in equity mutual funds.
This means that many investors, as usual, seem to be ignoring the most basic investment principle of asset allocation of not putting all their eggs into one basket. While small cap stocks and MFs that invest in such stocks may offer the chance of earning higher returns than other stocks, the chances of losses are also higher. Asset allocation diversity essentially ensures that this risk-return paradigm is taken into account while investing, so that investors don’t end up betting a significant portion of their investment on any one category of stocks.
This point is further elucidated by the fact that during April to July, much safer large cap MFs have seen net outflows of ₹5,239 crore. This could mean that investors are getting out of large cap MFs and betting their hand on small cap MFs, ignoring asset allocation advice. Further, let’s try and understand this point in a little more detail.
On 2 January 2007, the S&P BSE SmallCap Index stood at 7,004 points. By 7 January 2008, it had more or less doubled to 13,975 points, meaning a return of close to 100% in a little over a year’s time. By 9 March 2009, it had fallen by almost 80% to 2,867 points.
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