Effective Strategies to Reduce Losses in Small-Cap Mutual Funds

Small-cap mutual funds are equity mutual fund schemes that invest in small companies with a market capitalisation of less than Rs. 5,000 Crores. Small-cap companies lie beyond the top 250 companies in India, but offer a high growth potential. Due to their small size, these companies offer more room to grow and expand at a faster pace than established firms. However, small-cap funds also come with higher risks as these companies are more vulnerable to market fluctuations and economic downturns. If you are an aggressive investor seeking high returns in small-cap funds, you must also be prepared for losses. This article outlines the steps you can adopt to reduce losses in small-cap funds.

Here’s a list of 5 easy ways to reduce losses when you invest in small-cap funds:

Remain disciplined

One of the primarily loss reduction strategies in small-cap investments is to have perspective. Many investors are drawn to the high return potential of small-cap funds, often jumping into the category without fully understanding the risks involved or having a clear strategy. Investing with a definite perspective means investing with a well-defined objective and plan instead of impulsively putting your hard-earned money into small-caps. Before you begin with small-cap investments, make sure you conduct due diligent research on the underlying stocks, the fund’s investment strategy, fund manager, risk metrics, and past returns. Investing with a strategic approach in place means planning out your allocation proportion. For instance, if you want to allocate 75% to equities, you can consider dedicating 30% each to large and mid-cap funds and the remaining 15% to small-caps. The idea here is to start from a point of discipline to avoid impulsive and emotionally-driven decisions under panic.

Opt for the tried and tested

This is another strategy you can implement to reduce small-cap investment losses. The small-cap fund category is full of new and emerging funds that invest in new and emerging companies. If you fear a market downturn and wish to limit your small-cap losses, you can restructure towards the tried and tested options. There are several tried and tested names in the small-cap fund category that have generated good returns over the years, even while enduring market fluctuations.

Diversify your portfolio

Diversification is an obvious strategy to reduce losses from small-cap fund investments. Diversification helps spread risk and hedge the adverse effects of market downturns. Apart from diversifying your investments across asset classes, you should also consider internal diversification within the same fund category. For instance, if you invest Rs. 15,000 in small-cap funds every month, consider investing it in 3 different small-cap funds with different risk metrics instead of one fund. This helps reduce the risk of loss in small-cap funds, while maximising your return potential.

Accumulate in a planned manner

Apart from planning your investment, you should also plan the accumulation process to reduce losses with small-cap funds. In simple words, you should leverage the power of SIPs to tackle market volatility. Mutual fund SIPs allow you to contribute a fixed sum at regular intervals, regardless of the market condition. Consistent contributions under rupee-cost averaging helps overcome short-term fluctuations when you remain invested for a long duration. This phased approach to small-cap investments, coupled with a long-term horizon can effectively reduce the chances of losses when you invest in small-cap funds.

Stay in your comfort zone

Staying within your comfort zone is key to reducing potential losses when investing in mutual funds from the small-cap category. While it is easy to get swayed by the possibility of high returns, as an investor, you should stick to what you know. In other words, remain within your area of specialisation. For instance, if you have an understanding of the construction and chemical sectors, stick to them. Your knowledge will be an advantage you can leverage to assess the underlying assets and the fund’s performance. By aligning your investments with your knowledge, goals, and risk profile, you can make wise choices and avoid impulsive buys.

• Restructure your portfolio for tried and tested small-cap funds.
• Invest with a well-defined plan and the phased SIP mode.
• Prioritise what you know and diversify your investments to hedge risks.

Small-cap funds offer the unique advantage of cashing-in on the profits of growing enterprises. However, due to their intensely volatile nature, you must embody a cautious approach to shield your portfolio from losses. By investing with a disciplined plan, opting for tried and tested small-caps, sticking to your comfort zone, and contributing via a phased SIP, you can effectively reduce the possibility of losses in small-cap funds and protect your invested capital. Remember, reducing losses in small-cap funds is all about creating a well-balanced portfolio that hedges excess risks and remains diversified.

Wish to invest in the best small-cap funds in India? Head to the Bajaj Finserv Mutual Fund Platform where you can review the top 100 small-caps, compare mutual funds, and choose ones that meet your financial goals. Additionally, you can start SIPs from as little as Rs. 100 and compute returns using our ace Mutual Fund Calculator tool.