How to make money - Top tip! Is a small-cap mutual fund just what you were looking for? Find out

Mutual Fund Investments: Small-cap mutual fund schemes are the equity-oriented mutual fund schemes which have to invest at least 80 per cent of their corpus in small companies. The Securities and Exchange Board of India (SEBI) has defined small companies as companies that are other than the top 250 listed companies in terms of market capitalisation. So any scheme which invests and remains invested in at least up to 80 per cent of its corpus in these companies are categorised as small-cap funds and they are free to deploy their balance 20 per cent anywhere - debt funds or top 250 companies. 

According to to investment experts, because of their investment universe, small-cap mutual fund schemes are extremely risky. They can be beaten down drastically in a sharp fall in the stock market or on the slightest bout of volatility. But small-cap mutual fund schemes also have the potential to offer superior returns over a long period. This is because small-cap schemes bet on small companies with very high growth potential. When a small company becomes a very large company, the shares of the company would appreciate multiple times.

Elaborating upon which type of investor should invest in small-cap mutual funds, Balwant Jain, a Mumbai-based tax and investment expert said, "Small-cap stocks typically have the highest growth potential as the underlying companies are young, and seek to expand aggressively. They are more vulnerable to a business or economic downturn, making them more volatile than large and mid-caps. Investors who are keen to invest in the small-cap space and may not have the time to research but possess the high risk-taking capacity can look to invest in small-cap funds." 

Jain said that small-cap and mid-cap funds typically outperform large-caps during a bull market, but decline more when the sentiment turns bearish. So, the choice of the right fund should be in line with the risk appetite, return expectations and investment horizon of the investor.

On whether to link all long-term investment goals with small-cap mutual funds, Kartik Jhaveri, Director — Wealth Management at Transcend Consultants said, "Not necessarily".  He explained, "The choice of a particular product has to be based on various factors and not necessarily your time horizon for investing the money. So in case, your risk appetite is low, the small-cap category is not for you. Likewise, your ability to take a risk also is important for determining the product in which you should invest. At the start of your career, your ability to take risk is far higher than once you have crossed your 50 years of age. Please note that the risk appetite an ability t take are two different things. They are indeed volatile and risky in the short term, but they have the potential to offer superior returns over a long period.  Small-cap mutual fund schemes are meant for aggressive equity investors who can stomach a lot of volatility and risk."