The Indian equity market extends well beyond its largest and most familiar companies. Further down the market spectrum are smaller listed businesses, and small cap funds provide a way to invest in this segment without building a portfolio stock by stock.

Small cap exposure can come through actively managed funds, where the fund manager chooses securities according to the scheme mandate, or through passive funds, designed to follow a small cap index.

Take the Nifty Smallcap 250 as an example. It represents 250 companies ranked 251-500 within the Nifty 500. Other indices, such as the Nifty Smallcap 100 and Nifty Smallcap 50, cover narrower portions of the same broad segment.

The important point is that the term ‘small cap’ describes a market segment, not one portfolio. Before investing, you need to know whether the scheme is actively managed or follows an index fund, and in the latter case, which index it tracks.

Before investing in a Nifty Smallcap fund, ask yourself the following questions:

• Are you deliberately looking beyond larger companies: Small cap funds take you into a different part of the equity market, where the underlying businesses are smaller by market capitalisation.
• Can you give enough time for the investment to experience difficult phases: Small cap funds can see sharp price movements over shorter periods. Money linked to a near-term requirement may therefore be poorly matched with this kind of exposure.
• Would you rather access the segment through a portfolio than search individual companies: Evaluating smaller businesses one at a time can require considerable research. A small cap fund provides exposure to multiple companies within the segment.
• How much small cap exposure do you already have: Your existing equity funds may already invest in smaller companies. Looking at the portfolio as a whole can help you avoid adding more exposure simply because another small cap scheme looks attractive.
• How would you respond to a sharp fall in value: This matters because accepting the idea of risk is different from remaining invested when that risk actually shows up in your portfolio.

When you invest in a Nifty small cap fund, your money is pooled with investments made by other investors and allocated according to the scheme’s stated strategy. Let’s say you invest Rs. 70,000 in a Nifty Small cap fund.

Now, your sum of Rs. 70,000 is spread across all the companies in the fund’s portfolio, as per the index allocation.

Suppose the portfolio value rises by 15%. Then, your investment would become:

Rs. 70,000 + (Rs. 70,000 x 15%) = Rs. 80,500

However, the value can fall as well. If the portfolio value falls by 15%, then your investment would become:

Rs. 70,000 - (Rs. 70,000 x 15%) = Rs. 59,500

In the case of an active small cap fund, it is the fund manager’s responsibility to choose which stocks to buy, hold, or sell as per the scheme’s mandate.

On the other hand, a passive Nifty Small Cap fund tends to follow its chosen index, rather than actively selecting stocks or churning the portfolio.

There are multiple types of Nifty small cap indices, each covering the small cap market differently:

The choice of benchmark matters. Two passive small cap funds can both invest in smaller companies while still holding different portfolios because they follow different indices.

Before you decide to invest in a Nifty Small Cap fund, make sure to check the exact investment strategy of the scheme.

• A wider pool of smaller companies: Instead of depending on one or two small businesses, a fund spreads your investment across a larger portfolio. The number of holdings and degree of diversification will depend on the particular scheme.
• Access without building the portfolio yourself: Researching individual companies and their market performance can be demanding. With an active fund, security selection is handled by the fund manager within the scheme mandate. With a passive fund, portfolio construction follows the chosen benchmark.
• Easy benchmark tracking: In the case of index funds, you can track the performance of the fund against the index it follows to better understand how closely the two have moved.
• A distinct part of the equity market: Small Cap funds provide access to companies outside the larger-company universe. This can broaden equity exposure, although it also introduces the risks associated with smaller businesses.

• Prices can move sharply: Small Cap stocks may experience significant fluctuations, which can translate into noticeable changes in the value of the fund.
• Smaller businesses can face tougher company-level challenges: Issues related to financing, competition, business execution or weaker operating conditions can have a greater impact on individual companies.
• Selling conditions can become more difficult: Liquidity in smaller stocks can vary, particularly during periods of market stress.
• Diversification has limits: Owning several small cap stocks reduces dependence on one company, but all of those holdings still belong to the same broad market-cap segment.
• Returns remain uncertain: Neither active management nor following a small cap index guarantees that your investment will increase in value.

Here are some easy ways you can manage these risks:

• Maintain a suitable time horizon: Small-cap investments experience significant fluctuations in the short run, and thus, your investment period must match the risk level involved.
• Make use of SIPs: By investing at regular intervals of time through SIPs, you stand a chance to stay invested over different market levels.
• Diversify: Look beyond a single market-cap segment. Multi cap funds, for instance, invest across large-cap, mid-cap, and small-cap companies, offering a different type of exposure than a dedicated small cap fund.
• Check the Riskometer: As per the SEBI mandate, all mutual fund schemes are required to display a Riskometer, showing the level of risk associated with the scheme.

There are multiple Nifty small cap funds to invest in. Here is what to keep in mind before choosing a particular fund:

• Understand the type of fund: Check whether you are choosing an actively managed small cap fund or a passive fund that will track an index like the Nifty Smallcap 250.
• Check the underlying index: Check if the fund tracks the Nifty Smallcap 250, Nifty Smallcap 100, Nifty Smallcap 50, or some other benchmark.
• Check the expense ratio: The expense ratio is the cost of managing the mutual fund scheme. The expense ratio directly affects your returns.
• Check the risk involved: Make sure you check the fund’s Riskometer before investing.
• Match it with your goal: The fund’s risk level and your investment horizon should align with the financial goal you are trying to achieve with this investment.

Starting with Nifty Small Cap funds on Millions can be done in a few easy steps:

• Download the Millions app from the Google Play Store or the iOS App Store.
• Enter your details to open your account and complete the KYC process.
• Log in and search for small-cap funds on the platform.
• Before shortlisting a scheme, identify whether it follows an active or passive investment strategy.
• Review information such as the expense ratio, Riskometer, and other relevant scheme details.
• Enter the amount you would like to start investing with, choose the SIP frequency and date, and complete the payment.