What Are Small Cap Funds – 10 Powerful Facts You Must Know!

Today we will talk about what are small cap funds and why they can be an exciting part of your investment journey. Small businesses are the backbone of the economy, and they have a different charm in the stock market too. If you are looking for investments with high growth potential and are willing to take a little risk, then small cap funds can be a great opportunity for you.

Introduction: Small Cap Funds – Gateway to High Returns?

There are several types of mutual funds in the market – large cap, mid cap, and small cap. Each category has its own risk-return profile. But among all these, small cap funds are known for their unique characteristics. So, exactly what is small cap mutual funds? These are mutual funds that primarily invest in stocks of small-cap companies.

As per SEBI (Securities and Exchange Board of India) regulations, small-cap companies are those whose market capitalization rank is in the 251st position and beyond. Meaning, these are companies that do not fall in the top 250 companies in terms of market capitalization. These are often young, growing businesses with massive growth potential. Think of them as startups that are still in the race to become big players. If you feel you can identify a hidden gem, then small cap funds give you the opportunity to invest in them.

What are Small Cap Funds: A Deep Dive

When we talk about what are small cap funds, we are talking about funds that invest their major portion, i.e. less than 65% of their assets, in equity and equity-related instruments of small-cap companies. These companies typically have a smaller market capitalization as compared to large-cap and mid-cap companies.

The main objective of these funds is to invest in emerging companies that have the potential to show exponential growth in the future. Imagine a small plant that is about to turn into a big tree – small-cap funds invest in that plant. When that plant becomes a big tree, investors also get significant returns.

Is It Good to Invest in Small Cap Funds for Long Term?

Now this is a very important question: is it good to invest in small cap funds for long term? The answer is a resounding YES, especially if you have a high-risk appetite and a long investment horizon. Small-cap companies typically go through a more volatile phase in their early stages. But, if these companies become successful, they are able to provide exceptional returns to their investors.

Historically, small-cap funds have often outperformed large-cap funds over the long term. The reason for this is simple: the scope of growth is greater in some companies. An established large-cap company is already mature, its growth rate is limited. But a small-cap company that is innovating or capturing a niche market can grow multiple times.

According to a recent analysis, the Indian small-cap category has given an average return of 19% in the last 10 years (Source: Economic Times, June 2025). This data clearly shows how rewarding small cap funds can be for long-term investment.

How long should I invest in small cap mutual funds? Experts suggest that small cap funds should have an investment horizon of at least 7 to 10 years. This allows you to ride out the short-term volatility of the market and gives the fund time to take full advantage of the growth cycle of the companies.

Why Small Cap Mutual Funds Are Falling: Understanding Volatility

In recent times, you may have heard why small cap mutual funds are falling. Small-cap funds are inherently volatile. Their prices react more to market sentiment, economic conditions, and company-specific news.

In 2025, Indian small-cap funds saw a significant correction, with some funds falling by as much as 18%. The main reasons for this are:

1. Stretched Valuations:

After a period of strong performance, valuations of small-cap stocks turned very high (price-to-earnings ratios were well above historical averages), leading to profit booking.

2. Global Uncertainties:

Factors such as global interest rates, geopolitical developments, and domestic elections increased overall market volatility.

3. Regulatory Scrutiny:

SEBI and AMFI (Association of Mutual Funds in India) have issued cautionary statements about “froth” (overvaluation) in the small-cap space, causing some fund houses to pause or limit new investments.

These corrections are normal and can also be an opportunity for long-term investors to accumulate more units at a lower price through SIPs. Why small cap funds are falling is often a temporary phase, and they also recover according to the market cycle.

What is Mid Cap and Small Cap Funds: The Key Difference

Let’s see what is mid cap and small cap funds and what is the difference between them.

Small Cap Funds: As we discussed, these funds invest in companies with market capitalization rank of 251st position and above. These companies are young and have high growth potential as well as high risk.

Mid Cap Funds: These funds invest in companies that fall between 101st and 250th position in market capitalization rank. Mid-cap companies are not as stable as large-cap, but are not as volatile as small-cap. They have a good balance of stability and growth potential.

Basically, what is small mid and large cap in mutual funds, It is a classification based on the market capitalization of the companies they invest in:

Large Cap: Top 100 companies by market capitalization. (Stable, lower risk, moderate returns)

Mid Cap: 101st to 250th companies by market capitalization. (Moderate risk, good growth potential)

Small Cap: 251st company onwards by market capitalization. (High risk, high growth potential)

Should I Invest in Small Cap Funds: Who is it For?

Now the question arises that should I invest in small cap funds? Small cap funds are not for everyone. They are ideal for those investors who:

1. Have high risk tolerance: If you are not afraid of market fluctuations and can bear short-term losses, then small cap funds are for you.

2. Long investment horizon: Minimum 5-7 years, preferably 7-10 years or more. This gives you the full benefit of compounding.

3. Wealth creation goal: If your goal is significant wealth creation over the long term, then small caps can give you exceptional returns.

4. Want portfolio diversification: Small caps diversify your overall portfolio, as their performance is often independent of large and mid caps.

Who should invest in small cap funds?

Mostly young investors who have the time to invest over a long period of time and want aggressive growth, small cap funds are a good option for them. If you are close to retirement or your financial goals are short-term, it is better to avoid small caps.

Understanding the Difference: What is the Difference Between Small Mid and Large Cap Funds?

Let’s summarize what is the difference between small mid and large cap funds in a simple table:

Feature	Large Cap Funds	Mid Cap Funds	Small Cap Funds
Market Cap	Top 100 companies	101st to 250th companies	251st company onwards
Stability	High	Moderate	Low
Growth Potential	Moderate	Good	High
Risk	Low to Moderate	Moderate	High
Volatility	Low	Moderate	High
Investment Horizon	Short to Medium-term (3-5+ years)	Medium to Long-term (5-7+ years)	Long-term (7-10+ years)
Returns	Stable, consistent	Higher than large-cap, less than small-cap	Potentially very high, but inconsistent

What Are the Best Small Cap Index Funds: Passive Investing

If you want to avoid the high expense ratios of actively managed small cap funds or don’t want to depend on the performance of the fund manager, what are the best small cap index funds may be a good option. Small-cap index funds track specific small-cap indices such as the Nifty Smallcap 250 Index. Their aim is to replicate the performance of the index, and their expense ratios are usually low.

Some popular small-cap index funds in India include:

• Motilal Oswal Nifty Smallcap 250 Index Fund
• ICICI Prudential Nifty Smallcap 250 Index Fund
• Nippon India Nifty Smallcap 250 Index Fund

These funds are suitable for investors who want market-linked returns without the hassle of stock picking.

Conclusion: Your Path to High Returns with Small Cap Funds

Hope this blog post has given you comprehensive information about what are small cap funds. Small cap funds offer immense potential for wealth creation, especially for those who understand their dynamics and are willing to ride out the volatility with a long-term perspective. Remember, high returns often come with high risks, and small-cap funds are the perfect example of this rule.

Before starting your investment journey, always assess your risk tolerance and financial goals. And if needed, don’t forget to seek advice from a financial advisor. Market research and diversification can help you succeed in the small cap space.

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