Best small cap mutual funds to invest in 2022

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Investors are in love with small cap mutual fund schemes. The small cap category has offered around 56% returns in the last one year. Quant Small Cap Fund, the topper in the category, offered around 81% in one year. Obviously many investors fell in love with small cap schemes in 2021. They hope these schemes will repeat the performance in the coming year, too.

However, investing in small cap schemes comes with its share of risk. If you are planning to invest in a small cap scheme, this article may interest you.

You might have heard that investing in small cap schemes is risky. If you ever wondered, why? Well, small cap schemes invest in very small companies or their stocks. These companies go through many ups and downs – more than established companies in the large and mid cap segments.

As per the Sebi mandate, small cap schemes are mandated to invest in companies that are ranked below 250 in terms of market capitalization. These schemes also will have to invest at least 65% in small cap stocks.

It is not easy to identify winners in the small cap segment. Many of these companies are well known. They are also under researched. Their management can be unscrupulous and they can make big claims that can be unsustainable. Sometimes the management along with market operators can drive up prices. These are some of the reasons why the market rewards and punishes these companies disproportionately.

If these companies succeed, the market will be after these stocks and investors will suddenly have multi baggers in their portfolio. However, if they falter, the stocks would be severely punished. Overnight the stocks can become absolute dud.

In short, investing in small caps is not a child’s play. You will have to find successful fund managers who specialize in small cap stocks. You should also pay attention to how the schemes fared during the market downturn.

Here are some small cap schemes you can invest in the new year. But remember that it is essential to have a very high tolerance for risk, and an equally long investment horizon.

Best small cap funds to invest in 2022:

Our methodology: has employed the following parameters for shortlisting the Equity mutual fund schemes.

1. Mean rolling returns: Rolled daily for the last three years.

2. Consistency in the last three years: Hurst Exponent, H is used for computing the consistency of a fund. The H exponent is a measure of randomness of NAV series of a fund. Funds with high H tend to exhibit low volatility compared to funds with low H.

i) When H = 0.5, the series of return is said to be a geometric Brownian time series. These type of time series is difficult to forecast.

ii) When H <0.5, the series is said to be mean reverting.

iii) When H>0.5, the series is said to be persistent. The larger the value of H, the stronger is the trend of the series

3. Downside risk: We have considered only the negative returns given by the mutual fund scheme for this measure.

X =Returns below zero
Y = Sum of all squares of X
Z = Y/number of days taken for computing the ratio

Downside risk = Square root of Z

4. Outperformance: It is measured by Jensen’s Alpha for the last three years. Jensen’s Alpha shows the risk-adjusted return generated by a mutual fund scheme relative to the expected market return predicted by the Capital Asset Pricing Model (CAPM). Higher Alpha indicates that the portfolio performance has outstripped the returns predicted by the market.

Average returns generated by the MF Scheme =

[Risk Free Rate + Beta of the MF Scheme * {(Average return of the index – Risk Free Rate}

5. Asset size: For Equity funds, the threshold asset size is Rs 50 crore

(Disclaimer: past performance is no guarantee for future performance.)

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