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Is time to say goodbye to small cap mutual funds?

Market fall

Many mutual fund advisors have started asking general retail investors to stay away from small cap mutual fund schemes lately. They argue that small cap schemes have become extremely risky after the re-categorisation exercise by Sebi, and they don’t offer extraordinary returns to justify the extra risk taken by investors.

Suresh Sadagopan, founder, Ladder7 Financial Advisories, a Navi-Mumbai based wealth management firm, says small cap funds have always been risky.

“I think all good mutual fund advisors were always of the view that you shouldn’t go overboard in small cap schemes. There were good schemes in the small cap category which gave better risk-adjusted returns,” he says. “However, after re-categorisation of mutual funds, there is no place for deviating from the scheme mandates. So, the risk is clearly visible. Earlier, most schemes were running either like multi caps or mid caps. In this scenario, it becomes more important for investors to be doubly sure of these schemes,” he adds.

As per Sebi re-categorisation norms, small cap mutual funds are mandated to invest at least 65 per cent of their corpus in small cap stocks. Small cap universe, according to Sebi, starts from the 251st stock onwards in terms of market capitalisation.

As you can see, with their investment universe clearly defined, small cap funds do not have the freedom to switch to mid cap or large cap stocks when the going gets tough. Small cap stocks get brutally mauled during bad phases in the stock market.

For example, the small cap scheme category is down by around 17 per cent in the last one year. During the same period, large cap category suffered losses of 6 per cent, mid cap category around 14 per cent.

S R Srinivasan, Founder, Srinivesh Advisors, a Bangalore-based financial planning firm, says the problem with small cap schemes is not the risk, but the ratio of risk and returns. “If you are falling 10 percent more than mid caps, you should be able to give at least 15 per cent more returns. But in the case of small vs mid cap, the difference in returns is minuscule,” he says.

Over 10 years, the mid cap mutual fund category has given 14,.39 per cent returns, while the small cap category has offered 12.69 per cent returns in the same time frame. In five years, however, the returns are almost similar. The mid cap category has offered 9.51 per cent and small cap category has given 9.43 per cent average returns.

Srinivasan also says in India, the small cap companies suffer from corporate governance issues, liquidity etc. “They are vulnerable to defaults and problems which makes them riskier than mid cap companies.”

“I would say retail investors can skip the small cap category because they don’t provide extraordinary returns for the huge risk they come with. And this advice has nothing to do with the current market,” says Srinivasan. “We have been of the view that small cap schemes shouldn’t be more than 10 per cent of an average equity investor’s portfolio. Sure, there were investors who could take more small caps in their portfolio, but this advice is for general retail investors,” he adds.

Suresh Sadagopan says that if an investor has an asset allocation plan and small caps fit into that, the investors can go ahead and invest in them. “But for direct investors who buy one or two or three schemes without a proper plan, it is better to bet on multi caps. For those direct investors, who have a high risk appetite, I would say go for mid caps rather than small cap schemes,” he says.

[“source=economictimes”]

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