Do Not End Up Investing In Small-Cap Funds For The Wrong Reasons

The small-cap space is the centre of attraction for investors. There has been an explosion of investor interest in the small-cap fund space over the last few months. In June, the small-cap fund space saw a massive inflow of around Rs 5,470 crore, and this has been going higher as the interest balloons.

As an investor, if you are also thinking of investing in small-cap funds, it is important that it is done for the right reasons.

Here are some reasons that should not be the basis for investing in such funds:

The moment the equity indices hit new highs, there is a surge of interest among investors to participate in the rally and earn higher returns. The main route that many of them take is to go towards small caps because they seem to have the highest potential for gains.

As an investor, you should not decide your allocation within the equity portfolio based on the situation in the overall markets. It has to be based on your requirements and risk-taking ability. This is why 'the markets reaching new highs' should not be a factor that decides the investment in a small-cap fund.

The deluge of money that has come to small-cap funds in the last few months shows that investors have taken a liking to this segment. The possibility that someone you know is investing in small-cap funds is high. This kind of trend attracts more investors, as they do not want to miss out on the action. However, just because everyone else is investing in a particular space does not mean that you have to do the same, as your requirements for your goals would be different from others.

Your investments should not be based on the choices of others, as they might not be right for you.

Returns that the existing funds have generated are one of the most attractive factors that impact investors' decisions. Any investor who looks at the immediate past returns of the small-cap funds would find that these have soared not just in the last one-year but also over a three-year period.

In the last one-year, data from Value Research shows that the average return in small-cap funds was 27.9% and over a three-year period, it was 39.3% compounded annually as of July 11. This past return should not be the factor that influences the decision about selecting a small-cap fund.

A fund has to be in the portfolio only if there is a specific need for it; otherwise, it will only end up increasing the risk for the investor without contributing anything worthwhile.

There are some small-cap funds that have closed investments through the lump-sum route in recent days. There are specific reasons behind the move by each fund house, but this should not be taken as a situation where there will not be an opportunity to invest in the small-cap space. The closure of the lump sum investment is meant to protect the interests of investors, and this is no indication that there will not be an opportunity to take exposure to this sector. In fact, the same funds have kept the investment routes of the systematic investment plan and the systematic transfer plan open, so the investor can use this route at any point in time.

One needs to consider the developments in the right context, and then a proper decision should be made.

Arnav Pandya is founder Moneyeduschool