Is it safe to invest in small-cap funds? Should I allocate a small percentage to small caps or stick to large cap funds?

Investors who are not acquainted with the capital markets and just starting off usually are advised to start off with investing in large cap funds. Large cap funds invest in the largest companies across the country that have a proven track record and are covered by multiple analysts. Small caps on the other hand invest in a lot of unknown companies, many of who do not have a stellar historical record, but a lot of them seem to be on the cusp of high growth and make a big break through. The information available on small cap companies is limited and are also not covered extensively by analysts, hence there is an inherent risk.

Now let us take an example of two small cap mutual funds:

1)      HDFC Small Cap fund – Launched in 2014

2)      SBI Small Cap fund – Launched in 2013

Both these mutual funds have been around for over 10 years now and are amongst the top 5 small cap mutual funds in terms of AUM size. We are going to compare the annual returns these funds have generated against a large cap mutual fund and the BSE Sensex.

Table 1 – Returns of SBI Small Cap Fund – Direct Plan

Table 2 – Returns of HDFC Small Cap Fund – Direct Plan

Table 3 – Returns of SBI Blue Chip Fund – Direct Plan

Table 4 – Returns of BSE Sensex

Source: AMFI, Bseindia.com,  Note: The funds shown here are just taken for illustration purpose and in no way are recommendation for investment

The NAV taken for arriving at returns is the average NAV of the entire year for a mutual fund. Here we can see that the large cap mutual fund has given negative returns only in 1 year out of the 10 year period. However, out of the 2 small cap mutual funds, only 1 mutual fund has negative returns in 2 years and the other has given negative returns only in 1 year, same as the large cap mutual funds. In fact, even the BSE Sensex has given negative returns in 2 years out of the 10. This clearly shows that returns of small cap mutual funds are not as volatile and provide superior returns over large cap MFs. Hence investors with a long term horizon can look at small cap MF allocation for wealth creation.

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