Your money – Small-cap funds: Invest carefully to mitigate risks

financialexpress.com:

By Varun Fatehpuria

Small-cap funds became investors’ favourites during the first half of the year. The S&P BSE 250 Smallcap TRI delivered a positive return of 14.28% year-to-date, while the category as a whole witnessed net inflows of over Rs 17,800 crore until June 2023, according to data from the Association of Mutual Funds in India.

According to the categorisation by the Securities and Exchange Board of India, small-cap stocks are companies ranked 251 and below in terms of market capitalisation. These stocks typically exhibit lower liquidity compared to their large-cap or mid-cap counterparts, making them more prone to extended periods of extreme volatility.

The recent decision by Nippon India Small Cap Fund and Tata Small Cap Fund, with assets under management of over 28,000 crore and4,000 crore respectively, to stop accepting fresh investments highlights the limited opportunities that fund managers see in small-cap stocks in the current market cycle.

Here are a few reasons why investors must exercise caution when investing in small-cap funds:

Small-cap stocks, by nature, are characterised by higher volatility compared to their large-cap counterparts. Smaller companies are often more sensitive to market conditions, making them prone to wild price fluctuations. So, investors need to be prepared for heightened risk exposure when allocating a portion of their portfolio to small-cap funds.

Investors must also recognise that smaller companies often lack the same level of liquidity as large-cap stocks. Buying or selling substantial quantities of small-cap shares can be challenging, potentially leading to higher bid-ask spreads and greater transaction costs. This limited liquidity can make it harder for funds to exit