U-turn! 81% smallcap mutual funds underperform their benchmarks in 2024 so far

Around 81% smallcap mutual funds have underperformed their respective benchmarks in 2024 so far. There were around 27 smallcap mutual fund schemes in the market. Out of 27 smallcap schemes, 22 schemes have underperformed their respective benchmarks. In other words, only five smallcap schemes managed to outperform their respective benchmarks in 2024 so far.

UTI Small Cap Fund, the worst performer in the category, gave 0.54% in 2024 so far against 9.06% by its benchmark (Nifty Smallcap 250 - TRI). Union Small Cap Fund gave 1.64% in 2024 so far.



Among 27 small cap schemes, three schemes gave double-digit returns. Quant Small Cap, the topper in the category, gave 15.59% return in 2024 so far. Bandhan Small Cap Fund and ITI Small Cap Fund gave 10.45% and 10.03% returns, respectively.

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Nippon India Small Cap Fund, the largest scheme in the category based on assets managed, gave 6.14% in 2024 so far. Kotak Small Cap Fund gave 3.67% against 9.06% by its benchmark (Nifty Smallcap 250 - TRI).

Wondering what was the reason for this underperformance by the small cap schemes? “Small caps had a sharp increase in 2023 and were overvalued. Small caps are those stocks that are ranked 251 and above in market capitalisation, and therefore it is a very large pool for fund managers to select just 40 to 60 stocks. Moreover, the floating stock of small caps is low as majority is held by the promoters directly,” said Rajesh Minocha, a Certified Financial Planner (CFP), Founder of Financial Radiance.

He said, “By regulation, funds cannot refuse to honour any redemption request. So, once a redemption request is received for whatever reason, profit booking or anything else, the fund manager is forced to sell stocks at whatever valuation is available and higher redemption volumes put further pressure so they fall even more.”

The small and midcap space were in the limelight in the last few months as many of the less-tracked stocks gave multibagger returns despite valuation-related warnings by brokerages. The smallcap boom caught Sebi’s attention, which ordered mutual fund companies to run stress tests and declare the results publicly every fortnight.

The regulator also warned about froth building up in mid and smallcap segments. Mutual fund houses declared the stress test for their small cap and mid cap schemes.

Should you worry after the stress test results declared by the fund houses? “It is a natural tendency for layman investors, especially those new to investing, to invest based on past returns. Investments go through a sharp correction and we have witnessed that in 2008 and recently in the 2020 crisis. SEBI wants investors' money to be safe and therefore as per new regulations, they have asked the Asset Management Companies (AMCs) to do a stress test to check how many days it can take them to sell their 25% and 50% of the portfolio if there is a need,” says Minocha.

“Those schemes that have a higher Asset Under Management (AUM) could take much longer and whether that would happen or not would come out in these monthly stress test results by the AMCs. Investor protection is the primary goal of the regulators and I feel this is a step in the right direction so that investors can take a well-rounded judgement and then decide for themselves whether this category is suitable for them or not,” adds Minocha.

The small cap schemes are benchmarked against Nifty Smallcap 100 - TRI, Nifty Smallcap 250 - TRI, and S&P BSE 250 Small Cap - TRI. These schemes gave 8.79%, 9.06%, and 8.44% returns respectively in 2024 so far.

Nippon India Small Cap Fund, the largest scheme in the category based on assets managed, gave 6.14% against 9.06% by its benchmark (Nifty Smallcap 250 - TRI).

Now, the question comes: should one worry about their investments? Should one make investments into small cap schemes at the current point of time?

“Investors should not take undue risk and should invest only based on their risk appetite and time horizon and not based on short-term returns. Small caps should be considered as satellite investments for the portfolio and very high-risk investments should not be more than 10% and should be held for time horizons like 15 to 20 years. Patience will pay off eventually. New investors should avoid this in the beginning and gradually get into these investments after they have seen how investments work and have witnessed a complete cycle. Any investments with a time frame of less than 5 years should definitely not be invested in small caps,” recommends Rajesh.

Also Read | 5 smallcap mutual funds gave over 25% in 5 years. Have you invested in any?

ETMutualFunds further analysed the performance of small cap schemes in CY2023 with their respective benchmarks and found that the underperformance percentage of small cap schemes in CY2023 was 83%.

The small cap schemes have been underperforming against their respective benchmarks for two consecutive years, what is in future for small cap funds? “Small-cap schemes will continue to have volatility. Since, they are currently over-priced thanks to their run-up last year, we could expect higher volatility this year. But over a long-term period, they should work out fine if we have done our due diligence in selecting the right small cap fund,” said Minocha.

Note, all regular and growth option schemes were considered for the study. We calculated a return from January to April 2024.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)