Why a SIP in Small Cap Mutual Funds is a waste of money and time

Here is why a simple SIP alone in Small Cap Mutual Finds is far from rewarding in the long term and is a waste of your resources

Image of people travelling in a roller coaster representing a SIP investment in Small Cap fund and why they are a waste of time and money

Published: April 11, 2020 at 11:29 am

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Small Cap mutual funds are relatively new and came into the limelight after the market rally in late 2013. Looking at the stellar returns from this category in 2014, several SIPs were started, especially by young earners who told themselves that they had high-risk appetites that that “in the long term small cap fund would do better than large cap funds”. Here is why a SIP in a Small Cap fund is a terrible idea.

A second of wave new mutual fund investors joined in after 2016, and they were enticed by the high returns from small cap MFs in 2017 only to be frustrated ever since.

The trouble with a small cap fund is two-fold. One, they rise to extraordinary levels in a pretty short time and fall as fast – at the very least, this presents a buying opportunity. Two, they can take an incredibly long time to recover.

The BSE Small Cap index took about nine years to reach it’s 2008 pre-crash peak.  Actively managed funds may have taken a shorter time, but this is because they could freely invest in midcap and large cap stocks.

The previous all-time high for the index was Jan 2018. Currently is it almost 50% down and could take years to get out of the water. Yesterday we reported Ten-year SIP Return of Most Equity Mfs is now less than 10%

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Small cap Fund 10-year SIP Returns (9th April 2020)

SBI Small Cap Fund-Reg(G) 14.99
DSP Small Cap Fund-Reg(G) 9.15
Franklin India Smaller Cos Fund(G) 7.26
Kotak Small Cap Fund(G) 6.68
HDFC Small Cap Fund-Reg(G) 4.64
Sundaram Small Cap Fund(G) 3.76
Aditya Birla SL Small Cap Fund(G) 3.12
HSBC Small Cap Equity Fund(G) 2.99
ICICI Pru Smallcap Fund(G) 2.94

Seven funds with a less than 8% return after a 10-year SIP should be enough proof that “disciplined investing” is these funds offer a reward far inferior to the associated risk. Smallcap funds are significantly more volatile than other diversified mutual funds.  The associated risk premium ought to be higher, but that is rarely the case.

A simple long-term SIP would not lower associated risks and simply rise and fall with the fortunes of the fund.  The reason why the 10-year SIP return is so poor can be found by inspecting five-year returns.

Let us break the ten-year journey (April 2010 to April 2020) into five-year segments: April 2010 to April 2015 and April 2015-April 2020.

Small cap Fund 5-year SIP Returns (April 2010 to April 2015)

SBI Small Cap Fund-Reg(G) 33.78
HDFC Small Cap Fund-Reg(G) 20.08
Sundaram Small Cap Fund(G) 31.99
Kotak Small Cap Fund(G) 25.83
ICICI Pru Smallcap Fund(G) 22.74
HSBC Small Cap Equity Fund(G) 25.66
Franklin India Smaller Cos Fund(G) 35.51
Quant Small Cap Fund(G) 10.16
DSP Small Cap Fund-Reg(G) 35.16
Aditya Birla SL Small Cap Fund(G) 25.06

The first 5-year segment gave stellar returns. However, since SIPs do not reduce risk, all these returns were lost in the next five years!

Small cap Fund 5-year SIP Returns (April 2015 to April 2020)

L&T Emerging Businesses Fund-Reg(G) -8.65
Axis Small Cap Fund-Reg(G) 1.91
Union Small Cap Fund-Reg(G) -6.54
Nippon India Small Cap Fund(G) -4.76
SBI Small Cap Fund-Reg(G) 0.98
HDFC Small Cap Fund-Reg(G) -8.72
Sundaram Small Cap Fund(G) -13.32
Kotak Small Cap Fund(G) -6.70
ICICI Pru Smallcap Fund(G) -9.36
HSBC Small Cap Equity Fund(G) -12.92
Franklin India Smaller Cos Fund(G) -11.52
Quant Small Cap Fund(G) -13.01
DSP Small Cap Fund-Reg(G) -8.39
Aditya Birla SL Small Cap Fund(G) -0.14

This is the reason why the ten year returns are so low. What went up doubly fast, came down doubly fast and stayed there! While this risk is present in all equity funds, it is more pronounced for small cap funds.

What should investors do?

  • Avoid Small Cap mutual funds. They are not worth your time and money.
  • At the very least, do not invest in them via SIP. Buy them when NAV is down (like now!) and sell when they provide enough gains.
  • Beware of mutual fund sales guys they would push small cap SIPs with the dream of huge returns
  • Sell them when any fund in the category closes the fund for lump sum purchase
  • Or consider using technical indicators like for instance with this market valuation analyser
  • This is a study on how to book profits from mid cap and small cap funds tactically
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