Mid and small-cap funds invest predominantly in mid and small-sized companies to generate high capital appreciation over long term. While riskier than large caps, they offer higher return potential that can create substantial wealth of Rs. 15 crores and more if planned properly. Here are some tips for investing in these funds.
Understand market capitalization segments
Market cap refers to a company’s total market value based on its current share price and number of shares outstanding. SEBI defines large-caps as the top 100 stocks by full market cap. Mid-caps rank from 101-250 and small-caps from 251 onwards. Mid and small caps are riskier with higher volatility but have potential for greater growth.
Consider long tenure of 10+ years
Small and mid-cap companies are in growth phase and take time to mature into large-caps. Give at least 10-15 years for your investments to harness this high growth trajectory. Avoid short term horizons of 3-5 years. Have patience as some years will underperform large caps. Focus on long term CAGR.
Allocate higher amounts when valuations are reasonable
Valuations play an important role in mid/small caps given their volatility. Invest larger lumpsums when market corrections make valuations attractive. Stagger lumpsum investments instead of going all-in at once. Reinvest dividends to benefit from compounding.
Limit overall allocation to 20-30%
Due to the higher volatility of mid/small caps, limit their overall allocation in your portfolio to 20-30%. Diversify across multiple funds from leading fund houses. Avoid investing entire corpus in just 1-2 funds. Balance your portfolio with large-cap funds for stability and debt funds for safety.
Ensure fund aligns with mandate
Study portfolio and check that fund sticks to its mandate, with 65%+ allocation to mid/small-cap stocks. See portfolio composition, sector allocations, top holdings etc. Avoid funds that deviate materially from their stated focus on mid/small-cap space.
Choose experienced fund managers
Fund manager skills matter more in mid/small-cap segment. Look for experienced managers with proven track record of navigating market ups and downs. Review manager tenure and performance across market cycles before selecting a fund.
Monitor performance periodically
Review mid/small-cap fund performance at least every six months. Compare with category average and peer set to ensure the fund maintains top/upper quartile position. Redeem laggards and reinvest gains into better performers. Don’t become too emotional about a fund.
Utilize rebalancing to book profits
Rebalance portfolio annually to book profits in top-performing mid/small-cap funds and transfer gains to underperformers or large-cap funds. This locks in some gains, resets costs and maintains asset allocation. Avoid overexposure to mid/small-cap due to runaway growth in few funds.
Have long term goals for risk appetite
Link investments in mid/small-cap segment to specific long term goals like retirement, children’s education, house purchase etc. Keep 7–10-year horizon for each goal. This gives clarity on your risk appetite, tenure and required returns to achieve the target corpus.
Why invest in mutual funds?
If you are one of those investors still on the fence about opting for this route, here are a few compelling reasons that detail why investing in mutual funds is beneficial –
Higher growth potential – Mid and small-cap companies are in early growth stage and hence can provide very high returns over long term as they evolve into large caps.
Benefit from India’s growth story – Mid and small-cap funds allow investors to benefit from India’s economic growth by investing in fast-growing companies at an early stage.
Diversification – Mid and small-cap funds provide diversification to a portfolio heavily invested in large-cap funds.
Lower market correlation – Mid and small-caps exhibit lower correlation with broader markets compared to large caps. This provides stability during market downturns.
Wealth creation over long term – Mid and small-cap funds carry higher risk but have potential to create substantial wealth over long investment tenures of 10 years or more.
By following a disciplined long-term approach, diversifying across funds, limiting overexposure, reviewing performance, rebalancing periodically and evaluating taxes, you can effectively tap into the high growth potential of mid and small-cap mutual funds. Ignore short term volatility and focus on long term wealth creation to accumulate a sizable corpus.