Top 5 small-cap mutual funds for investment

It is the right time for mutual fund investors to increase their exposure to small-cap funds. The BSE Small-Cap index has once again begun to outperform the large-cap indices after a period of underperformance. The BSE Small Cap index is up 3.3 percent since the start of the 2023 calendar year compared to a 1.2 percent rise in the benchmark BSE Sensex index during the period. The BSE Sensex comprises the country's top 30 companies and as such is a large-cap index. 

The small-cap stocks were ahead of their large-cap peers even on Wednesday. The BSE Small index was up 0.25 percent on Wednesday compared to a 0.6 percent decline in the Sensex during the day.

In comparison, the Sensex was up 4.4 percent during the 2022 calendar year while the BSE Small Cap index was down 1.2 percent during the period.

Most analysts expect that small-cap stocks will continue to outperform large-cap indices. Historically, the relative performance of small-cap and large-cap stocks follows a cycle. For example, the BSE Small Cap index (up 63 percent) outperformed the Sensex (up 22 percent) in the 2021 calendar year by a wide margin. 

So if history is any guide, the performance gap of the small-cap index over the large-cap is expected to widen further during the remaining months of CY23.

The best way to take advantage of this trend is to invest in top-ranked small-cap mutual funds. We have put together five best small-cap equity mutual funds that offer the best combination of superior long-term and short-term returns. 

These funds also score high on quality parameters such as risk-adjusted returns, volatility and portfolio concentration. As such investors can expect these top-ranked small-cap funds to have superior returns irrespective of the market cycle. 

The analysis is based on the data from ICRA Analytics. Our sample only includes open-ended small-cap funds with a performance history of a minimum of three years. Secondly, our analysis is restricted to regular growth schemes of these funds.

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All the top five funds in our list have delivered higher than the category average returns in the last six months, one-year and three-year periods. Small-cap funds have delivered 20.9 percent returns on average in the last year and 42.4 percent annualised returns in the last five years. In comparison, in the last six months, small-cap funds delivered 5.1 percent absolute returns. 

Here are the top five small funds worthy of your investment 

1. HSBC Small Fund is the top-ranked fund in our league table with 25 percent returns in the last 12 months and 47 percent annualised returns in the last 3 years, both higher than the category average. The fund with an asset under management (AUM) of nearly Rs9200 crore also scores high on risk-adjusted returns (Sharpe ratio) and volatility. Its portfolio is the most diversified among peers with the top 5 securities accounting for only 15 percent of the total assets.

2. Tata Small Cap Fund is next on our list with 25 percent returns in the last one-year and 45.2 percent annualised returns in the last three years, both higher than the category average. The fund with an AUM of around Rs3900 crore also scored high on quality and risk parameters such as Sharpe ratio, standard deviation and portfolio beta. The top securities or stocks in its portfolio account for nearly a quarter of its assets, which is on the higher side.

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3. HDFC Small Cap Fund is ranked third in our list with category-leading returns of close to 33 percent in the last 12 months. The fund with an AUM of nearly Rs16,000 crore has delivered 46.7 percent annualised returns in the last three years, once again better than the category average returns of 42.7 percent. The fund is also among the ten best funds in quality and risk parameters such as Sharpe ratio, standard deviation and portfolio beta. The fund portfolio concentration with top-five accounting for 22 percent of the assets is however slightly on the higher side. 

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4. Edelweiss Small Cap Fund is ranked fourth with 22.5 percent and 42.4 percent annualised returns in the last one-year and last 3 years respectively, both higher than the category average. The fund, with an AUM of around Rs1600 crore, is also among the top ten on quality and risk parameters.

5. Nippon India Small Cap Fund is ranked fifth in our list with 28 percent returns in the last 12 months and 49 percent annualised returns in the last three years, both higher than the category average. The fund, with an AUM of nearly 26,300 crores, also has one of the best risk-adjusted returns (Sharpe Ratio) and one of the most diversified portfolios among its peers.

Happy Investing! 

(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).

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