Navigating the Roller-Coaster of Small-Cap Funds

In the last 14 months, Small-Cap funds have generated returns that are nearly unprecedented. While their impressive performance may be enticing, it’s crucial to understand the inherent risks before diving in. The performance of small-cap funds and companies is highly cyclical. Historically, they tend to outperform or surge for 15-18 months before pausing to start their next phase of growth. 

For instance, from June 2006 to January 2008, the small-cap index tripled, only to plummet by almost 75 per cent. Similarly, between February 2016 and January 2018, the index gained 2.2 times before dropping by 65 per cent by the end of March 2020, coinciding with the onset of the corona virus-triggered pandemic. The current rally in small-caps appears to be a few months away from peaking, having already gained more than 70 per cent. 

Small-cap companies, despite their immense growth potential, are inherently volatile. The very trait that propels their rapid rise can also lead to swift declines. Last year’s stellar performance should not obscure the intrinsic volatility of this asset class. Recency bias may tempt investors to believe this hot streak will continue indefinitely, but history shows that small-cap funds often soar initially only to falter later. If you are considering a small-cap fund investment, remember that it’s a marathon, not a sprint. 

These funds are best suited for investors with a long-term horizon—ideally more than five years. This timeframe allows you to weather the inevitable volatility and potentially benefit from the long-term growth these companies offer. Let me reiterate: Manage your risk. Don’t allocate an excessive portion of your portfolio to small-caps, no matter how promising they seem at the moment. A balanced, diversified approach with a focus on long-term goals will serve you far better than chasing short-term gains in this volatile market segment. Invest wisely, with patience and prudence, to navigate the exhilarating yet unpredictable landscape of small-cap funds. 

Shashikant Singh
Executive Editor