1. Surging Indices

Smallcap mutual funds primarily invest in smallcap stocks while midcap mutual funds buy and sell midcap stocks. These stocks form a part of broader indices known as the S&P BSE Smallcap and the S&P BSE Midcap.

Both these indices have surged dramatically over the past year. In fact, the pandemic phase excluded, both indices have performed strongly over the past 5 years. 

1. Surging Indices

Smallcap mutual funds primarily invest in smallcap stocks while midcap mutual funds buy and sell midcap stocks. These stocks form a part of broader indices known as the S&P BSE Smallcap and the S&P BSE Midcap.

Both these indices have surged dramatically over the past year. In fact, the pandemic phase excluded, both indices have performed strongly over the past 5 years. 

As you can see, the rapid growth of smallcap and midcap indices has made smallcap and midcap mutual funds, a relatively less risky way of investing in the stocks in the indices, more desirable and lucrative for investors.

2. Potentially High Returns

Investing in smallcap and midcap mutual funds has historically been one of the best ways to generate potentially better returns than largecap funds. Remember, these funds invest in smallcap and midcap stocks.

Companies classified as smallcap and midcap are generally budding organizations in their nascent stage. Thus, they have the potential to grow more rapidly than a largecap company that’s already well established.

3. Future Prospects

Like we discussed moments ago, smallcap and midcap companies have the potential to break into the territory of largecap companies. This would impact their stock positively and in turn, the mutual fund’s returns.

The potential to grow into a company with a largecap worthy market cap coupled with the lucrative historical returns may entice investors to invest in smallcap and midcap funds. 

After all, who wouldn’t want to invest in the next Amazon or Apple in a relatively less risky fashion with mutual funds? That said, the factors that make smallcap and midcap mutual funds popular also have downsides.

1. Not All Winners

We discussed how the smallcap and midcap indices have been surging over the past few years. Great, does this mean all smallcap and midcap funds did well over the same period? Not actually. 

There are two reasons for this: 

• Smallcap and midcap funds hold certain stocks that are a part of these indices (unless you’re talking about index funds) 
• It takes only a few high performing stocks to propel or drag an index

In fact, multiple bad stocks within a mutual fund’s portfolio can effectively erode your returns, especially in a volatile space like smallcap and midcap. Thus, it’s very important to evaluate factors like the:

• Smallcap or midcap fund’s management team
• Investment philosophy of the management  team and AMC
• Historical track record and AUM
  

Doing the legwork and analyzing the smallcap and midcap fund space requires diligence and time. If you’re a working professional, time may be very hard to come by. Tap here to see the solution

2. High Risk & Volatility

While smallcap and midcap funds can potentially generate better returns than largecap funds, they are known to carry relatively higher risk. In fact, smallcap and midcap stocks are known to experience wild price swings.

The reason behind this lies in the inherent nature of smallcap and midcap companies - they’re not as stable as large companies. Flash in the pan news or financial reports may swing investor behaviour. 

This can directly impact the value and returns of the mutual funds that invest in them. That’s why smallcap and midcap mutual funds are generally suitable for investors who are willing to stay patient for 5+ years.

3. Past Return ≠ Future Success  

You must’ve heard this phrase countless times, “Past performance does not guarantee future success”. It’s almost always true, especially in the case of investment options like mutual funds. 

Just because a smallcap or midcap fund performed well in the past year does not mean that it’ll continue to perform well in the next 3, 5, or 10 years. There are factors in the future that may affect returns.

Only trained financial experts like Wealth First, Cube’s mutual fund advisor, can assess that. In fact, they go beyond historical returns and evaluate 12+ complex factors to curate the best mutual funds on Cube.