Invest in small-cap funds to gain from their potential to generate alpha

Small-cap funds, with total assets under management of Rs. 1,42,200 crores, appear to be experiencing a resurgence.

- Sudipta Mitu

After a meagre average return of 1.34 per cent in 2022, these funds have achieved a year-to-date average return of 5.4 per cent, surpassing the 1.37 per cent increase of large-cap funds and 3 per cent of mid-cap funds.

There are several reasons why retail investors favour the small-cap fund category. Over the past 10 years, these funds have provided investors with an average return of 19.9 per cent, surpassing both large-cap funds (12.65 per cent) and mid-cap funds (18.06 per cent). Out of the 10 active funds in this category with a 10-year track record, seven have outperformed the S&P BSE small-cap index, which returned 17.2 per cent during the same period.

The small-cap universe is vast, encompassing all stocks beyond the top 250 by market capitalization. This universe is less extensively researched compared to large-cap and midcap stocks, offering mutual fund managers a greater opportunity to discover hidden gems and undervalued stocks. Consequently, there is a greater probability of them delivering alpha for their investors in this category.