Small Cap Mutual Funds

Small-cap mutual funds are open-ended equity schemes that invest at least 65% of the total assets in equity and equity-related securities of small-cap companies. As per SEBI’s definition, small companies are those companies that rank 251st and onwards in terms of full market capitalization.

Though smaller in size as compared to both large-cap and mid-cap companies, small cap companies often function in dynamic and emerging industries, positioning them for greater potential for growth. However, such companies also tend to be more sensitive to market fluctuations, economic shifts and access to capital. So, investors having higher risk tolerance and seeking higher returns from their long-term investments can choose to invest in small-cap funds.

• Invests in small cap companies - The portfolio of such mutual fund funds comprises of Small-cap mutual funds invest their total assets predominantly in small-cap stocks . 
• High growth potential - This type of mutual fund has the potential to offer substantial growth to investors over the long.
• Portfolio comprising of stocks with potential of growth prospects
• Higher risk and market volatility - Its investments in companies in the early development stage can be volatile and are subject to greater risk.
• They may outperform mid- and large-cap funds in a bull market and underperform in a bear market.     

• Small cap mutual funds pool money from various investors and invest their assets in small cap companies.
• Then a fund manager selects a diversified portfolio of such companies based on their growth potential, financial health and market outlook.
• The value of the fund (NAV) changes every day, depending on how the stocks that the fund invests in are doing. 

• Small-cap companies are at an earlier stage of growth and can provide higher long-term returns, but they also tend to have higher price fluctuations than large or mid-cap stocks. 

Investors looking to invest in small-cap mutual funds can do so through Paisabazaar. Follow these simple steps to begin your investment journey:

1. Open the Paisabazaar app on your mobile.
2. Click on ‘Mutual Funds' on the homescreens. 
3. Explore mutual funds by clicking on ‘View All’. 
4. Select ‘Small-Cap’ under category and choose one mutual fund that fits your risk-appetite and investment horizon. 
5. Start your SIP or One-time investment.

Depending on how long the investor remained invested, capital gains from the redemption of small-cap equity fund units are subject to taxation. We refer to this time frame for investments as the holding period. Small cap mutual funds are therefore subject to the same taxes as other equity-oriented funds.

Short-Term Capital Gain

If you buy and sell your small-cap mutual fund units within 12 months or less, your profit is considered a short-term gain. As per section 111A of the income-tax Act 1961, the short term capital gains on transfer of units on or after 23 July 2024 shall be taxable at the rate of 20% regardless of your personal income tax slab rate.

Long-Term Capital Gain

If you hold your small cap mutual funds for more than 12 months, your profit is considered as long-term capital gain. As per section 112A of the income tax act, redemption of units on or after 23 July 2024, LTCG above Rs 1.25 lakh per financial year is taxed at 12.5% without indexation benefits.

Tax on IDCW

If you choose the Income Distribution Cum Capital Withdrawal (IDCW) option instead of Growth, you receive periodic payouts from the fund, which are taxed as per your income tax slab.

If your total IDCW payout from a fund house exceeds Rs 10,000 in a financial year, the fund house deducts 10% TDS before making you the payment. 

A Simulated Example of Selling a Small-Cap Fund

Suppose, you invested Rs 5 lakh into a small-cap mutual fund, and it grew to Rs 7 lakh. So your gross profit would be Rs 2 lakh.