Are Small-Cap Funds Still Lucrative?

While the high growth potential of small-cap funds is enticing, the investment comes with a significant downside. Compared to large-cap funds, small-caps experience deeper maximum drawdown during market downturns. The article examines the how, why and when of investing in small-cap funds

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Small-cap funds on an average have generated return of 54 per cent in the last one year, which remains one of the highest among equity categories. In the last three years, on an annualised basis, it has generated return of 27 per cent, which means that on an absolute basis it has given return of more than 100 per cent. For example, one of the best performing small-cap funds, Quant Small-Cap Fund has generated return of 224 per cent between March 2021 and May 2024. In the same period, Invesco India Small-Cap Fund and HDFC Small-Cap Fund have generated returns of 142 per cent and 148 per cent, respectively. Even among the not-so-good performing funds in recent times, Union Small-Cap Fund has generated return of 119 per cent in the same period.

Such returns have attracted many investors towards these funds. Since the start of February 2021, investors have poured in a net amount of ₹74,501 crore in small-cap funds. From our study of the last 39 months, it was only in four months when there was a net outflow from small-cap-dedicated funds. Out of these outflows, not a single time was the net outflow more than ₹500 crore. In June 2023, small-cap funds attracted investments of ₹5,471 crore, highest in recent times.

The gain in small-cap index along with huge inflow has led to a significant increase in the assets under management (AUM) of small-cap funds. This has increased from around ₹67,700 crore in February 2021 to ₹266,109 crore currently, spiralling upward at an annualised rate of more than 50 per cent in the period under consideration.