Should You Continue Investing In Smallcap And Midcap Funds?

Smallcap and midcap funds have been in the news recently for multiple reasons. First off, Nifty Smallcap 100 has grown by nearly 600 points while Nifty Midcap 100 has surged by 2000 points since 08-09-2021. 

Furthermore, there were “price cap” directives issued by BSE in August 2021 to curb the “manipulation” of smallcap stocks. This move led to both smallcap and midcap stocks tanking in 08-2021, albeit briefly. 

That said, smallcap and midcap mutual funds have been known to be a lucrative proposition for patient investors. But does that mean you should continue investing in smallcap and midcap mutual funds? Let’s find out.

Why Have Small-Cap and Mid-Cap Funds Become Popular?

2021 has been a year of volatility topped off by relatively high gains for both smallcap and midcap mutual funds in India. Here’s why. 

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.

What Are The Cons Of Investing In SmallCap And Midcap Funds?

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.

Should You Invest In Smallcap And Midcap Funds In 2021?

All things considered, smallcap and midcap mutual funds do have benefits that can be useful to investors who want to achieve certain financial goals in the distant future. 

But, not all smallcap and midcap funds are made equal. Some have a good management team while others may not have the tools to weather rampant volatility. Other asymmetries exist as well. 

Thus, it’s best to consult a trained and reliable financial expert who can help you set up a portfolio of smallcap and midcap mutual funds that are well-researched, diversified, and top-quality. 

Sounds like Cube to you? Check out the app!

Note:

Facts & figures are true as of 07-10-2021. All information mentioned is for educational purposes and relies on publicly available information. None of the information shared here is to be construed as investment advice. We strongly recommend you consult a Cube Wealth coach before investing your money in any stock, mutual fund. PMS or alternative asset.