A small cap fund is an equity mutual fund that invests in small-cap stocks. In India, SEBI guidelines mandate the categorisation of listed companies based on their market capitalization. According to SEBI categorization, large cap funds invest in the top 100 companies by market cap, mid cap funds invest in the next 150 companies, and small cap funds invest in the remaining companies (251st company and beyond).

Small cap mutual funds have the potential to offer higher returns than large cap and mid cap funds, as they invest in emerging businesses that have the scope to grow exponentially. However, they also carry very high risks, as they are more volatile and susceptible to market fluctuations.

Here are some reasons why you must include small cap mutual funds in your investment portfolio:

• Diversification: Small cap mutual funds could help you diversify your portfolio and reduce your overall risk. They can also provide exposure to different sectors and themes that may not be well represented in large cap and mid cap funds.
• Growth potential: Small cap mutual funds could help you capture the growth potential of emerging businesses that have innovative products or services, strong management, and competitive advantages. These businesses may become the market leaders of tomorrow and generate superior returns for investors.
• Value discovery: Small cap mutual funds may help you discover undervalued or overlooked stocks that have strong fundamentals and growth prospects. These stocks may offer attractive valuations and higher margins of safety compared to large cap and mid cap stocks.
• Long-term horizon: Small cap mutual funds are suitable for investors who have a long-term horizon of at least 5 to 10 years. They may help you benefit from the power of compounding and ride out the market volatility. They may also help you achieve your long-term financial goals such as retirement planning, probable wealth creation, or children's education.

However, before investing in small cap mutual funds, you must also consider the following factors:

• Risk appetite: Small cap mutual funds are not for those who are afraid of taking risks. They can experience sharp ups and downs in their performance and may even underperform the broader market. You must have a very high risk appetite and a strong conviction to invest in them.
• Fund selection: Small cap mutual funds require more research and analysis than large cap and mid cap funds. You must choose a fund that has a consistent track record, a robust investment process, and a competent fund manager.
• Asset allocation: Small cap mutual funds should not form a major part of your portfolio. You must have a balanced asset allocation that suits your risk profile, investment objective, and time horizon. You must also review and rebalance your portfolio periodically to maintain your desired allocation.

Small cap mutual funds can be a rewarding addition to your investment portfolio if you are willing to take very high risks for probable higher returns. You must do your homework before investing or consult your Mutual Fund Distributor.

Disclaimer: The views expressed in this article are personal in nature and are in no way trying to predict the markets or to time them. The views expressed are for information purposes only and do not construe to be any investment, legal, or taxation advice. Any action taken by you on the basis of the information contained herein is your responsibility alone and Tata Asset Management Pvt. Ltd. will not be liable in any manner for the consequences of such action taken by you. Please consult your Mutual Fund Distributor before investing. The views expressed in this article may not reflect in the scheme portfolios of Tata Mutual Fund. The view expressed are based on the current market scenario and the same is subject to change. There are no guaranteed or assured returns under any of the schemes of Tata Mutual Fund.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.