Investors are continuously flocking to small-cap funds, the Association of Mutual Funds in India (AMFI) data shows. In July 2023, small-cap funds saw a dip in inflows, recording Rs 4,171 crore compared to June's Rs 5,472 crore. However, these funds remained in the spotlight, securing the highest inflows within the equity categories. Notably, the mid-cap fund also garnered Rs 1,623 crore in inflows.

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An interesting pattern emerges as both small-cap and mid-cap sectors have consistently outperformed the larger large-cap space for several months. During July, the Nifty 50 index grew by 1.4 percent, while the Nifty Small-cap 100 index soared by 6.4 percent, and the Nifty Midcap 100 index surged by 5.5 percent. This phenomenon has not gone unnoticed, with Viraj Gandhi, CEO at SAMCO MF, who remarked that the concentrated market action underscores the potential of these segments.

The trigger

Small-cap funds present an avenue for investors to tap into lesser-known, promising businesses. As these businesses make strides, investors can potentially reap quick gains. Moreover, the diversification benefits of these funds are noteworthy.

By incorporating small-cap funds into a portfolio, overall diversification can be bolstered, cushioning the impact of lacklustre performances from larger firms and utilising various market niches to temper portfolio volatility, experts say.

Mukesh Kochar, National Head-Wealth at AUM Capital, sheds light on the positive yet tempered inflows. Market valuations are not deemed cheap at this juncture, prompting investors to exercise caution in selecting entry points. Nevertheless, the allure of India's growth narrative and historical performance continues to contribute to incremental fund flows.

"It's worth noting that the term small-cap doesn't necessarily mean micro-sized companies. Companies in this segment have a reasonable market presence and business scale. For instance, the starting point of the small-cap space is represented by the 251st company with a market cap of around 22,000 crore, while the 500th company stands at roughly 8,500 crore market cap. These companies combine reasonable size and growth prospects with relative valuation appeal," he said.

Hence, investors remain drawn to the perceived outperformance of small-cap funds, which commanded 54.7 percent of the net equity fund inflows. This trend underscores the strong attraction towards these funds, fueled by their remarkable performance and potential for lucrative gains in the current market landscape.

The returns

Most of the small-cap funds have given over 20 percent annualised returns in 1 year.

Here's a look at 1, 3 and 5 years returns of some small-cap funds:

(Source: Moneycontrol)

Should you continue investing?

Experts say that investors should moderate return expectations going forward and should consider the small-cap category only if they have a long-term investment horizon and can stomach the volatility.

On top of these, risk tolerance and portfolio diversification should always be accessed before investing in any avenue.

First Published:Aug 11, 2023 5:03 PM IST