Why do investors believe that small-cap, mid-cap and thematic funds are a good bet for the future?
This article is authored by Mukesh Kochar, National Head of Wealth at Aum Capital
Small-Cap, Mid-Cap, and thematic funds are considered to be great investments if you are looking to achieve a higher return over the long run by investing in them. Even though these funds carry higher risks, if investors are able to navigate them carefully, then they can reap significant benefits in the future. It is important to remember that these funds require patience and discipline. Short-term swings in the market can be unpredictable and can lead to large losses. Therefore, investors should invest for the long term and be prepared to ride out the highs and lows of the market.
There has been much debate among retail investors as to whether mid- and small-cap funds are worth the risk, even though they have experienced colossal growth over the past few years. By looking at some of the key benefits of the segments, you can make an informed and deliberate choice that will help you make a more informed and deliberate choice:
Reasons why small-cap, mid-cap, and thematic funds are the right investments for the future.
- Potential for growth: Compared to Large-Cap funds, mid and small-cap funds are growing at a rampant pace. Mid-cap funds invest in companies that are remote to stability and growth exhibited in large caps, but show promising growth in the coming years. Likewise, small-cap and thematic funds offer growth opportunities upon the good performance of a company or theme. Based on historical data, investors generally add top-performing funds into their portfolios. However, funds performing well in current statistics may or may not produce the same outcomes in the future. With this regard, investors must also look at the fund’s performance consistency and its outperformance to benchmark.
- Risk-adjusted return: While selecting a fund from the market, it is crucial to see the risk-adjusted returns as performance in isolation does not offer any concrete outcome. For instance, a fund with a return of 10 per cent but with higher volatility would not be as beneficial as a fund with a return of 5 per cent but with lower volatility. Investors on that account should also consider risk ratios like the Sharpe ratio, Standard derivative, and Beta among others. Thematic funds are comparatively volatile as they invest in a concentrated portfolio. This marks them appropriate for investors with high-risk appetites.
- Diversification: Just like a platter full of dishes offers distinct tastes to your palate, diversifying your portfolio allows you to experience returns across different asset classes. It allows you to spread your money across a diverse array of asset classes. Diversification should be the choice for every investor looking for robust returns from a long-term perspective. It can be as personal as buying a car or saving for your retirement.
Investors should necessarily invest in liquid funds to mitigate portfolio risks. It is difficult to generate alpha in small-cap stocks since they have low liquidity. Moreover, thematic funds that focus on particular niches may also face liquidity risks. As a result, investors must look for mid-cap stocks as they have moderate liquidity due to their market reputation, share and capital size. While examining a fund, It is also important to look into its size.
Funds with higher AUM may underperform in a downward-trending market followed by an outflow of funds during redemption. However, some funds have been able to perform better even with higher AUM due to proper diversification and regular rotation.
Conclusion
Investing in mid- small, and thematic funds is a good choice for investors aiming for long-term prospects. However, before hopping to any conclusion, investors must perform thorough research on the fund as well as its fund manager. It is crucial to examine the fund manager running the show, owing to which investors must look at their track record in the previous funds managed by them.
Every fund manager follows a different pattern of investment, where some abide by value investing, and some prefer a growth strategy. Few fund managers may also look at investment growth at reasonable valuations. Investors should ensure that all the selected funds have different styles of investment theses. When it comes to portfolio diversification, investors should have at least 5-8 funds based on the size of the portfolio, ensuring that overlapping of holding should at least get the benefit of proper diversification. However, over-diversification must also be avoided as they may impact the overall performance of the portfolio.
Disclaimer: The opinions expressed above are personal and may not reflect the views of DSIJ