<p>Every large cap company started small in the past. Several companies have grown to be market leaders with sound financial performance and proven track records from humble beginnings. Investing in small companies during their initial stages of growth allows investors to generate better returns when small cap companies' valuations get re-rated with the business's growth.</p>
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<p>However, in the large crowd of small cap companies, it becomes crucial for investors to spot the right companies to invest in, as not all small companies may grow big. This is where professionally managed small cap mutual funds help potential investors. Instead of investing in such companies directly, such investors may consider investing in <a href="https://www.utimf.com/mutual-fund-products/equity-funds/uti-small-cap-f… cap funds</a> to gain similar investment exposure with professional fund management of the money invested.</p>
<h2 style="font-size:21px"><strong>What is a small cap fund - Meaning of small cap funds</strong></h2>
<p>SEBI guidelines prescribe the categorisation of listed entities based on their market capitalisation. According to these guidelines, a small cap fund means a fund that predominantly invests in the equity shares of small cap companies. While the top 100 companies in such a list are termed large- cap companies, the next 150 companies, i.e., from 101 to 250, are termed <a href="https://www.utimf.com/mutual-fund-products/equity-funds/uti-mid-cap-fun… cap</a> companies. The companies featuring beyond 250th rank is termed as small-cap companies. A small cap fund invests a minimum of 65% in the equity shares of small cap companies.</p>
<p>The recent SEBI guidelines for defining the risk grades for <a href="https://www.utimf.com/mutual-fund-schemes/">mutual fund schemes</a> assign a high-risk value to small-cap securities within the investment portfolio. While large-cap securities are assigned a market cap value of 5, mid-cap and small-cap securities are assigned 7 and 9, respectively. Since small-cap funds have a predominant share of small-cap securities within the investment portfolio, such funds have a higher probability of categorisation under the 'High Risk' or 'Very High Risk' grade.</p>
<h2 style="font-size:21px"><strong>Why invest in small cap funds</strong></h2>
<p>Investors may aim to invest in different companies in the initial growth phase and maybe the next market disruptor. Such companies, thus, carry immense potential for growth and <a href="https://www.utimf.com/articles/wealth-creation-through-mutual-funds/">w… creation</a> . There might be some success stories and a few failed ones in the growth phases, as small-cap companies may not have a lengthy history of financial performance to vouch for them. As such, the investors need to spot the right companies and at the right valuations. Small-cap funds make it easier for investors to invest in a diversified portfolio of small-cap companies.</p>
<h2 style="font-size:21px"><strong>Who should invest in small cap funds and why?</strong></h2>
<p>Small cap companies tend to have a higher gestation period to reach their real value. Thus, small cap funds may be volatile in the short run while encapsulating the potential of higher returns in the long run. Accordingly, investors with an aggressive risk appetite and a long-term investment horizon may only consider investing in such funds.</p>
<h2 style="font-size:21px"><strong>Tax incidence on returns from small cap funds</strong></h2>
<p>Gains from <a href="https://www.utimf.com/">mutual funds</a> may be in the form of dividend income or through appreciation in the NAV of the fund. While dividend income is added to the regular income of the investor and taxed accordingly, gains are taxed as Capital Gains at the tax rates depending upon the type of fund and holding period. Small-cap funds are classified as <a href="https://www.utimf.com/articles/equity-oriented-mutual-fund-schemes-expl… funds</a> under income tax laws.</p>
<p>The gains from small-cap funds are categorised as STCG (Short-Term Capital Gains) if the holding period is less than 12 months or LTCG (Long-Term Capital Gains) if the holding period is 12 months or more. STCG is taxed at 15% (plus applicable surcharge and cess), while LTCG is taxed at 10% (plus applicable surcharge and cess) without any indexation benefit. The investors are also eligible for ₹1 lakh exemption regarding LTCG from equity shares and equity-oriented mutual funds in aggregate in a year.</p>
<p>With the implied volatility of such schemes being higher, the investors may invest in such funds to aim for better returns, albeit with higher risk. Therefore, one should make a conscious decision about investing in such funds after striking a balance between their risk appetite and portfolio risk profile.</p>
<p>Disclaimer:</p>
<p><strong>Mutual Fund investments are subject to market risks, read all scheme related documents carefully</strong>.</p>
<p>The tax provisions mentioned in the article are for illustrative purposes only and are updated as per the Union Budget presented in the Parliament in February 2022. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/sales</p>