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Are you considering investing in Small Cap Mutual Funds but have no idea where to start? This blog will help you understand everything you need to know. We will discuss the detailed process and filters used in selecting the best funds for the investments. By the end, you'll feel more confident about choosing the good small cap fund for you. Now let us get started.
Two Styles of Investing in Small Cap Funds?
There are two main strategies you might think about when investing in the small cap Equity Category: Buy & hold and Active Investing Strategies
- Buy and Hold Approach:
In this approach, we do bottom up analysis to find those small companies or businesses at the very early phase of their growth. Thereafter, we buy those small companies at low valuations and hold them for many years till they become established companies. This type of strategy has successfully given very high in the long term.
One excellent example of a portfolio constructed using a Buy and hold strategy is the Nippon India Small Cap Fund. The fund's main strategy is to find fast-growing small cap companies at an early stage and buy them at low valuations, indicated by low PE ratios. This is a key reason why Nippon Small Cap Fund gives an average annualised returns of 22% returns for any five years of investments and that’s stand out as top performing small cap funds.
For a detailed analysis of this fund's portfolio, click here.
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- Active Investing Approach:
In this approach, we select cyclical businesses or growing companies that are trending in the market. This requires buying at the right time and exit once the earning of the companies slowdown. This kind of strategy is perfectly fits in the bull phase when market or specially small cap stocks are in good momentum. Therefore, they delivers very high returns in short period of time.
For example, Quant small cap fund is a top performer in its category, delivering an average annualized return of 44% over any 3-year investment period. Quant small cap use predictive analysis to find the trending small cap stocks that shift from neglected zone to admirable zone hence giving very quick and high returns on their investment.
For a detailed analysis of this fund's portfolio, click here.
How to Select Best Strategy for Small Cap Investing?
Which investment style is most appropriate for you will depend on a few important factors:
Time Horizon
It relates to how long you want to keep your investments.
- Long Term: A buy-and-hold strategy can be suitable if you want to invest for several years or decades as it reduces transaction costs and helps you take advantage of compounding.
- Short Term: Active investing might be better if you're investing for a shorter time, like a few months or years, because you can take advantage of short-term market trends.
Risk Tolerance
Risk tolerance is how prepared you are to accept changes in the value of your investments.
- Buy and Hold:This strategy, which may be appropriate for investors with a lower risk tolerance, is usually seen as less risky because it involves holding into investments through market ups and downs.
- Active Strategy:Active investing comes with a higher level of risk since it involves frequent buying and selling of investments. As such, it may be more appropriate for investors who are willing to tolerate a larger degree of risk in exchange for the chance to earn higher returns.
Financial Goal
Your financial objectives, such as saving for retirement or purchasing a home, are what you want to achieve with your money.
- Wealth Building: A buy-and-hold strategy can be the best option if your goals are to save for your child's education and retirement. This approach aims to build wealth for the future by gradually increasing investments over time.
- Maximizing Returns: Active investing can be a better option if your main objective is to maximize investment returns and you are ok with the high risk. By strategically purchasing and selling stocks, this approach seeks to beat the market. It may result in larger profits, but it also carries a higher risk.
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Top Parameters used in Selection of Best Small Cap Funds
To choose the best small cap fund, you need to consider several factors.
1. Find Fund Strategy
Knowing the fund strategy is Important for investors It's about understanding how the fund manager selects which small cap stocks to invest in, which industries they prefer, and how they handle risks. By understanding this, investors can identify fund style is buy & hold or active investing, this information is available in the presentation of schemes published by mutual fund companies
2. Manager consistency
In small cap funds, the fund manager is the sole person responsible for the fund's performance. It depends upon their skill set and experience in handling small cap stocks and their volatility. Always prefer funds that have experienced fund managers and consistently managed funds for at least 3-5 years.
3. Size of fund and liquidity
The size of a fund is an important factor to consider when investing, large AUM-size funds have difficulty investing money in small cap stocks as they are less liquid stocks. So entry and exit are both very difficult. Small AUM-sized funds have more scope to properly utilise money in small-cap stocks. Consider funds having AUM of more than 500 crores and less than 20000 crores
4. Returns consistency
Consider small cap Mutual Funds that have a good track record of consistently generating high returns in the market. One or two times good performance is a big trap. Therefore, consider looking at rolling returns, which calculate the average returns for a specific duration. To make the most informed choice, select funds that have been generating at least 18% average annualized returns for 3 to 5 years of investment duration.
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5. Portfolio Quality
When you are evaluating investment funds for your portfolio, it's important to pay attention to their revenue and earning growth. Ideally, you should look for funds that have a high earning growth rate compared to both the benchmark and the category average. Additionally, it's a good idea to check the valuation of the fund, which can be measured by its price-to-earnings (PE) ratio. Generally, you have to choose funds with a lower PE ratio than the benchmark, as this can indicate that the fund is undervalued and has room to grow. By carefully considering these factors, you can make more informed investment decisions and build a stronger, more profitable portfolio.
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6. Expert Advice
Consulting with financial advisors or specialists may be quite beneficial. Individual recommendations may be provided by them depending on your investing goals, your tolerance for risk, and the time horizon of your investment. They also have the ability to examine fluctuations in markets, fund performance, and economic developments. You will be able to allocate your funds more wisely in this way.
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Final Statement
Investing is easy when you focus on a few key factors. Consider your investing strategy, risk tolerance, and financial objectives. Whether you prefer a stable approach or want to strongly manage your money, build your plan to match your preferences. Seek advice from financial experts for personalized guidance. To effectively handle market fluctuations, use a SIP (systematic investment plan). By prioritizing all of these factors, you may invest wisely and achieve your financial objectives with ease.
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