MF Query Board
I am looking to invest in small-cap funds. How long do I need to invest in them? Is an investment horizon of five years right? And which fund should I opt for? - Subhadeep Ghosh
This is a really pertinent issue and most investors are asking it because they have witnessed the spectacular success of small-cap funds over the previous two years and believe it is a profitable investment. However, things are not as simple as we may believe. To determine how long you should remain invested in small-cap funds, we conducted research in which we used the one-year, three-year, five-year, seven-year and ten-year rolling returns of the Nifty Small-Cap 250 Total Returns Index (TRI). Furthermore, we calculated the risk in terms of maximum drawdown. This will assist you in understanding the maximum losses that you should be prepared for if you decide to invest in small-cap funds.
As can be seen, the median returns given by the Nifty Small- Cap 250 TRI are nearly identical across all timeframes. Obviously, the risk would change depending on the time span. This, however, offers you an indication of what to expect from small-cap funds. We analysed the returns distribution to have a deeper understanding of the returns expectations.
It is observed that if you invest in small-cap funds for seven years or longer, you have a much lower probability of receiving negative returns, and your return expectations should be between 10 per cent and 20 per cent. However, if you invest for five years, you have a 50:50 probability of failing to beat inflation.
If we look at the maximum drawdown of the Nifty Small-Cap 250 TRI, it is negative 75.6 per cent. However, the average drawdown is negative 22 per cent. Furthermore, it has been noticed that if it goes below 10 per cent, the odds are that it will continue its losses. As a result, we believe that the best investment horizon for small-cap funds is seven years or more. This is due to the fact that the possibilities of receiving negative returns after seven years are reduced. Additionally, investing in them through a systematic investment plan (SIP) makes more sense. The funds listed below are options for you to consider.
