Mitigate valuation risk in smallcap funds with limited exposure, long horizon

While returns over the past year have been high, these funds are prone to significant drawdowns during tough economic environments

- SARBAJEET K SEN

Investors who had chosen smallcap funds some time ago are a happy lot today. Over the past year, smallcap equity funds have, on average, returned 54.7 per cent as of April 10, 2024. The steep rise has also led to mounting concerns, with the Securities and Exchange Board of India (Sebi) mandating stress tests on these funds. It raised questions about some fund houses selling these 'high-risk' funds to senior citizens. In March 2024, the category witnessed outflows (of 94.2 crore) for the first time since September 2021.

A diverse mix

While some companies in the smallcap universe are market leaders in their respective businesses, many others have not yet gained critical mass and a solid balance sheet.

"Contrary to general perception, many small-caps have dominant market share in sectors such as cables, logistics, durables, forging, chemicals, auto ancillaries, and their growth longevity and quality of management are excellent," says Ajay Khandelwal, fund manager, Motilal Oswal Asset Management Company.

Deepak Jain, president and head-sales, Edelweiss Mutual Fund says, "Many emerging sectors, which are likely to benefit from the overall growth in India, may currently be part of the smallcap universe."

Room for growth