Small-cap funds: Investing in emerging companies for maximum upside

Small-cap funds are growth-oriented equity mutual fund schemes that invest in emerging companies with the potential to deliver high returns. These funds are best suited for investors who can handle a higher degree of risk in pursuit of long-term gains. If you're considering adding small-cap funds to your portfolio, here’s what you need to know.

What are small-cap funds?

Small-cap funds invest primarily in companies with a market capitalisation of less than ₹5,000 crores. These firms typically fall outside the top 250 listed companies on stock exchanges and are often in their early growth stages. The strategy behind small-cap investing is to tap into the rapid growth potential of these businesses before they become mainstream.

What are the potential benefits?

Historically, small-cap funds have delivered strong returns. For example, the Quant Small Cap Fund has posted an impressive five-year annualised return of 40.83% (as of March 2025). Such performance highlights the considerable upside potential that small-cap funds offer, especially for investors willing to ride out market fluctuations in pursuit of long-term gains.

What risks are involved in small-cap funds?

The same factors that make small-cap funds attractive also contribute to their risk. Smaller companies often lack the financial strength and stability of larger firms, making them more vulnerable to economic downturns and market volatility.

As a result, small-cap funds can experience significant short to medium-term fluctuations. However, these risks can be mitigated with a long-term investment horizon, ideally seven years or more, allowing time for these companies to mature and deliver returns.

Who should invest in small-cap funds?

Small-cap funds are best suited for investors with a high risk tolerance and a long-term investment outlook. If you’re comfortable with short-term volatility and can stay invested for at least five to seven years, small-cap funds can add significant growth potential to your mutual fund portfolio.

How to invest in small-cap funds?

You can invest in small-cap funds through a Systematic Investment Plan (SIP) or via a lumpsum investment. SIPs are particularly useful for managing risk over time, as they allow you to invest smaller amounts regularly and benefit from rupee cost averaging and compounding.

For instance, the Quant Small Cap Fund allows SIPs starting at just ₹1,000, making it accessible to most retail investors looking to build long-term wealth.

Conclusion

Small-cap funds present an exciting opportunity to invest in the future leaders of the market. While they come with higher risk and volatility, the potential for substantial long-term gains makes them a good choice for aggressive, goal-focused investors.

However, before you invest in a small-cap fund, it’s essential to match such investments with your financial goals and risk appetite. Consulting a financial advisor can help determine whether small-cap funds are the right fit for your investment strategy.