If you are an investor in small-cap and mid-cap mutual fund schemes, or are thinking of investing in them, you are not alone in this. Many investors in India are investing in these mutual fund schemes and are keen to invest in them in search of higher returns and exciting investment stories.
However, the question that arises in everyone’s minds is that despite all the hype and excitement about small and mid-cap mutual fund schemes, is it still a good time to invest in them or is it a good time to step back and reassess things?
Well, to answer that question, it is a known fact that small and mid-cap mutual fund schemes are capable of giving higher returns to their investors. However, it is also a known fact that higher returns are not free, and there is a cost attached to it in the form of higher risks involved. So, it is important to understand this before you take any decision in this regard.
Should You Consider Investing in Small-Cap Funds?
What Are Small-Cap Funds?
Small-cap funds invest a significant portion of their money in equity or equity-related instruments of small-cap companies. According to the Securities and Exchange Board of India (SEBI), small-cap companies are those ranked below the 250th position based on market capitalisation. These businesses typically have a market cap of less than ₹500 crores.
SEBI also mandates that small-cap mutual fund schemes must allocate at least 80% of their assets to small-cap companies.
Why Do Small-Cap Funds Attract Investors?
The appeal is simple — growth potential. Small companies, by definition, have room to grow. If a small business does well and expands, its share price can rise dramatically. Investors who got in early stand to benefit the most.
Think of it this way — today’s small company could be tomorrow’s market leader. And if you invest in it before it becomes big, the returns can be remarkable.
In fact, the small-cap sector in India has seen phenomenal growth in recent years. Returns from small-cap funds have sometimes exceeded 100% or more in a single year. That kind of performance is hard to ignore.
But Here’s the Catch
Small-cap funds are highly volatile. Even a small amount of market turbulence can significantly impact the share prices of small companies. When markets fall, small-cap stocks tend to fall the hardest.
Many investors make the mistake of investing in small-cap funds for short-term gains. But this approach can backfire. Small businesses need time to grow, and their stock prices can swing wildly in the short term. If you panic and pull out during a downturn, you could end up locking in losses instead of gains.
Advantages of Small-Cap Funds
- Early entry into potential market leaders — You get the chance to invest in companies before they become big names.
- High growth potential — Small companies can grow rapidly, leading to significant returns.
- Ideal for aggressive investors — If you have a high-risk tolerance and an investment horizon of 7 years or more, small-cap funds can be a powerful wealth-building tool.
Factors to Consider Before Investing in Small-Cap Funds
Before you put your money into small-cap funds, here are some important things to think about:
1. Understand the Risk-Return Trade-Off
The NAV (Net Asset Value) of a small-cap fund is highly sensitive to changes in its underlying benchmark. When market conditions turn sour, many small-cap funds experience significant losses.
But here’s the flip side — avoiding risk entirely means missing out on potential returns. If you skip small-cap funds because of the risk, you might also miss out on the kind of returns that can truly accelerate your wealth creation.
The key is to go in with your eyes open. Understand that there will be ups and downs, and be prepared to ride them out.
2. Choose a Fund with a Lower Expense Ratio
If you’re new to investing, here’s something important to understand. Every mutual fund company charges a fee for managing your money. This fee is called the expense ratio, and it’s expressed as a percentage of the fund’s total assets.
SEBI has set the maximum expense ratio at 2.50%. But within that limit, different funds charge different amounts. A higher expense ratio means more of your returns go towards covering the fund’s costs instead of staying in your pocket.
So when you’re comparing small-cap funds, always check the expense ratio. Choosing a fund with a lower expense ratio can make a noticeable difference to your returns over time.
3. Small-Cap Funds Work Best in the Long Run
Because small-cap stocks are highly vulnerable to market fluctuations, short-term investing in this category can be very risky. These stocks tend to suffer the most during market corrections.
However, if you give your investment enough time — ideally 8 to 10 years or more — the volatility tends to smooth out, and the growth potential of these companies has time to play out.
If you have an aggressive investor profile and a long-term investment horizon, small-cap funds could be a great fit for you.
4. Not Suitable If You Can’t Handle Volatility
This is worth repeating. Small-cap funds are not for the faint-hearted. If watching your portfolio value drop by 20% or 30% in a bad month makes you anxious, this might not be the right category for you.
However, if you can stomach the ups and downs, consider allocating a small portion of your overall portfolio to small-cap funds. You don’t have to go all in. Even a modest allocation, held over a long period, can significantly boost your overall portfolio returns.
Should You Consider Investing in Mid-Cap Funds?
What Are Mid-Cap Funds?
Mid-cap funds invest in the stocks and securities of mid-cap companies. As defined by SEBI, mid-cap companies are those ranked between the 101st and 250th positions based on market capitalisation.
To give you a sense of scale:
- The 101st company on the list has a market cap of approximately ₹30,000 crores
- The 250th company has a market cap of around ₹9,500 crores
These companies sit right in the middle — bigger and more established than small-cap companies, but smaller and more agile than large-cap giants.
Why Mid-Cap Funds Are Appealing
Mid-cap companies offer a unique balance of risk and return. They combine some of the stability of large-cap companies with the growth potential of small-cap companies.
Here’s how they compare:
- Compared to large-cap funds: Mid-cap funds are more volatile, but they typically deliver higher returns.
- Compared to small-cap funds: Mid-cap funds offer lower returns, but they are more stable and less prone to extreme price swings.
In other words, mid-cap funds occupy the sweet spot between safety and growth.
If you choose your schemes carefully — looking at stock selection, sector diversification, and the quality of the fund manager — you can expect solid returns from mid-cap funds over the long term.
Advantages of Mid-Cap Funds
- Exposure to high-growth stocks that have the potential to outperform the broader market.
- Better stability than small-cap funds, making them slightly less nerve-wracking during market downturns.
- Suitable for active investors with a time horizon of 7 years or more.
Factors to Consider Before Investing in Mid-Cap Funds
1. These Funds Are Best for Long-Term Investors
Like most equity investments, mid-cap funds perform best when held for the long term. The beauty of mid-cap investing is that many of today’s mid-cap companies will become tomorrow’s large-cap companies.
If you invest in these companies while they’re still growing, you stand to benefit significantly as they mature and expand. But this growth takes time. An investment horizon of 8 to 10 years is typically recommended.
2. Returns Can Be Inconsistent in the Short Term
Mid-cap funds have a strong track record of delivering impressive returns over the long term. However, in the short to medium term, their performance can be unpredictable.
There will be phases when mid-cap funds underperform. During market corrections or bear markets, these funds can give negative returns. The key is to stay invested through these rough patches and not make emotional decisions based on short-term performance.
If you’re patient enough to hold your investment through market cycles, mid-cap funds can reward you handsomely.
3. Not All Mid-Cap Companies Succeed
Here’s something many investors forget — not every mid-cap company grows into a large-cap. Some mid-cap companies struggle to grow, and in extreme cases, some have even filed for bankruptcy during challenging market conditions.
If a company in the fund’s portfolio fails to meet its growth expectations, it can drag down the overall returns of the fund. This is why it’s so important to invest in well-managed funds with experienced fund managers who know how to pick the right companies.
4. Keep an Eye on the Expense Ratio
Just like with small-cap funds, the expense ratio matters a lot in mid-cap funds too. Every fund house charges this fee to cover management and operational costs. SEBI’s maximum limit is 2.50%, but lower is always better.
A fund with a lower expense ratio puts more of your money to work, leading to higher returns on your investment over the long run. Always compare the expense ratios of similar mid-cap funds before making your choice.
Mid-Cap vs Small-Cap Funds: A Quick Comparison
| Parameter | Small-Cap Funds | Mid-Cap Funds |
|---|---|---|
| Company Ranking (by Market Cap) | Below 250th | Between 101st and 250th |
| Market Cap Range | Less than ₹500 crores | Approximately ₹9,500 – ₹30,000 crores |
| Risk Level | Very high | High (but lower than small-cap) |
| Return Potential | Very high | High |
| Volatility | Extremely volatile | Moderately volatile |
| Ideal Investment Horizon | 8–10+ years | 8–10+ years |
| Best Suited For | Highly aggressive investors | Active investors with moderate-to-high risk appetite |
So, Is It the Right Time to Continue Investing?
The answer to this question isn’t a simple yes or no. It depends on who you are as an investor.
If you have a high-risk appetite, a long investment horizon of 7 to 10 years or more, and the patience to ride out market volatility, then yes — continuing to invest in small and mid-cap funds can be a smart strategy.
These funds have historically delivered strong returns over the long term, and there’s no reason to believe that well-managed companies in this space won’t continue to grow.
However, if you’re someone who gets nervous during market dips, or if you need your money back within the next 2 to 3 years, these fund categories may not be the right fit for you right now.
A Few Practical Tips
- Look at past performance carefully. Choose small and mid-cap funds that have consistently beaten their benchmark indices and peer groups — not just in bull markets, but also during bearish phases.
- Check how they handle downturns. A good fund doesn’t just deliver great returns in a rising market. It also controls downside risk during a bear market. Look at how the fund performed during past corrections.
- Review the portfolio. Take some time to look at what the fund is actually investing in. Understand the companies and sectors where your money is going.
- Use them as satellite holdings, not core holdings. Instead of making small and mid-cap funds the centerpiece of your portfolio, include them as a satellite allocation. This means they make up a smaller portion of your overall portfolio but add a meaningful boost to your total returns.
Final Thoughts
Small-cap and Mid-cap funds are exciting segments of the investment arena with tremendous scope for generating high returns. But, these segments are not for the faint of heart, and the risks are high.
The key to these segments, like any other investment, is to approach them with clear and disciplined minds. Know your risks, be honest with yourself, and don’t try to chase returns blindly or sell your investments in the face of market turbulence.
With proper homework and discipline, small and Mid-cap funds can be useful tools for creating wealth. But, don’t forget, each and every investment decision must be with reference to your financial objectives. What might be good for one investor might not be good for the next. Take your time, do your research, and if need be, consult a financial advisor before making any major investment decision.
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Disclaimer: This blog is solely for educational purposes. The securities/investments mentioned here are not recommendatory. Please consult your financial advisor before making investment decisions.
