Small Cap Equity Funds have been in the eye of a storm ever since a prominent fund manager expressed his opinion on this category at the prevalent valuations. Several others were of a contrary opinion and the electronic media had a field day flogging this debate longer than needed.
So, what exactly are these Small Cap Equity Funds?
They are those funds that must mandatorily invest at least 65% of their assets in equity stocks of Small-Cap companies, as per SEBI’s categorisation of funds. Small-Cap companies are defined to include all companies whose market cap is lower than that of the 250 largest companies (in terms of market capitalisation) listed in the Indian stock market.
A popular theory among many wealth managers is that it is better to avoid Small Cap Equity Funds, or at best, allocate a relatively smaller portion of the portfolio to them to steer clear of a bad hit in the event of a vertical fall in the market which in turn could adversely impact the overall performance of one’s portfolio.
While there might be merit in the above belief, one must always remember that Investing is an Art and not a Science and hence cannot be bound by rules and formulae. Simply put, the above rule of avoiding or not investing in small-cap equity funds cannot be applied in the same measure to two individuals at opposite ends of the Investment Life-Cycle stage or to a person with a drive to maximize their investment returns coupled with a high-risk appetite.
At the early Investment Life-Cycle stage, for example, and with all other factors being equal, the risk appetite of an investor is likely to be higher than that of another individual closing in on retirement towards the end of their Investment Life Cycle.
Like with all other investment vehicles where the underlying asset class is Equity, one must give small-cap equity funds the luxury of time to perform. While there may be times when it provides handsome short-term gains too, serious investors intent on wealth creation have more often than not, thrived by staying invested for longer time frames that include at least one economic cycle. This is even more so because, unlike the large and mid-cap companies, small-cap companies are lesser known and less researched, with relatively lesser-known management too.
As far as its taxation is concerned, based on the underlying asset, it qualifies for Equity taxation. It is taxed at the rate of 12.5% for Long Term Capital Gains (LTCG) made on the sale of units priced at over Rs.1.25 lakh, and 20% for Short Term Capital Gains (STCG) if the units are sold within the time frame of 1 year from the date of allotment of units.
And thus, while Small-Cap equity funds may not merit an across-the-board blanket ban for investors, those including it in their portfolios must do so after calibrating its risks.
(Ashok Kumar heads LKW India. The views expressed here are his own)