For investors, the usual investment debate goes around growth potential vs. risk tolerance. One option for such investors is small cap funds. They are aggressive, volatile, but rewarding if you are investing in it for a few years, such as your medium-term goals. But the big question remains: are they a good option? Let’s break it down.
What Are Small Cap Funds?
Small cap funds put your funds into the smaller, up-and-coming names on the stock exchange, those that come after the top 250 in market rankings. These companies are often newer and focused more on rapid expansion.
Because of their size, small cap companies are more vulnerable to market movements and economic changes. But during recovery or growth cycles, they usually tend to outperform.
Why Do Small Caps Continue to Draw Investor Attention?
Over a 10-year horizon, small cap funds have often outpaced large and mid cap categories in returns. But what about a 5-year period? Let’s consider the SBI Small Cap Fund, one of the top performers in the category. As of April 2025, the fund has delivered:
- 30.47% CAGR over 5 years.
- Assets under management (AUM) of over ₹ 31790.25 Cr.
- A diversified portfolio across manufacturing, chemicals, and financial services.
This is just one example. Past performances of many of these funds have been lucrative, but can the trend continue?
Well, India’s economic trajectory still supports the case for small caps. The push for manufacturing, digital transformation of SMEs, and government schemes like PLI (Production Linked Incentives) are all tailwinds.
That said, volatility has increased. Global headwinds, inflationary pressures, and interest rate uncertainty mean small cap funds could swing both ways; that too very fast.
So, the real question now is: how do you align small cap funds with your medium-term financial goals?
How to Align Small Cap Funds for Mid-term Goals?
Here are a few scenarios where small cap funds might still fit into a 5-year plan:
1. You are Starting Early
If you are young and just beginning your investment journey, small caps offer growth potential you may not find elsewhere. You can afford short-term bumps while focusing on long-term gains.
2. You are Investing Through SIPs
A Systematic Investment Plan (SIP) spreads your investment over time, helping you average out volatility. If you are looking for the best SIP for 5 years, small cap funds can be a part of your portfolio. In fact, SIPs work particularly well during market downturns, letting you buy more units at lower NAVs.
3. You are Okay with Tactical Allocation
Not all your money needs to go into small caps. Even a 15-20% allocation can lift your portfolio’s returns. Combine it with either large cap and debt funds for a balanced mix.
However, unlike large-cap funds, small caps are more affected by economic and sector-specific news. Timing your entry and exit may influence your returns, especially over shorter time frames like 3–5 years. Anyways, pair them with more stable options like large cap funds or short-term debt instruments to lower your risk.
Final Thoughts
Small cap funds aren’t for conservative investors. However, they’ve shown their strength over the years. The key lies in how you use them: wisely, patiently, and with a plan.
If you are disciplined with SIPs and comfortable with temporary market swings, small caps may still meet your medium term targets and even exceed expectations. That said, always consider your long-term goals and risk appetite to ensure your asset allocation aligns with your goals.
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