Small-Cap Mutual Funds - FAQ for Investors
High growth stocks are always attractive to investors, even at the cost of higher exposure to risk. Before we get into how you should strategize small-cap investing, let’s get a handle on what exactly small-cap funds are. The term small cap refers to the market capitalization of the company in question, which could be anywhere between $300 million and $2 billion.
And small cap mutual funds are simply mutual funds aimed at providing an investor ownership of small parts of these high-growth, high-risk companies. Please note that these funds are not limited by law to small cap stocks, but that the objective of the fund is to provide high returns to investors and thus a higher weightage is given to small cap stocks. Also to be noted is that the exact quantification and definition of a stock as small cap is subject to differing views, depending on the brokerage.
Small cap funds have a high degree of volatility linked to market trends and investor sentiment. A bullish run on the market is likely to boost these stocks much more than it would a big corporation or an established company. Similarly, other factors, such as industry legislation, or a tie-up or merger or any positive indicator is likely to boost these stocks. This is because these stocks are basically undiscovered and undervalued, unlike companies with massive market capitalization, where demand for shares has already driven the price well above the market. The other side of the coin is that these stocks are also vulnerable to investor panic, and if the market drops, small cap stocks will go down, irrespective of strong fundamentals.
Small cap mutual funds are more reassuring to investors, rather than direct investments into these companies, since the returns are higher than from a conventional mutual fund, while the risks are mitigated by the likely success of a maximum number of the stocks included in the index.
The trick here is to spot a small cap mutual fund which has a track record of spotting new companies with long term prospects. You are advised to study each mutual fund, the historical data and the associated management fees and administrative charges to determine the fund which offers maximum returns.