Why Did the Assets of Small-cap Mutual Funds Fall 83% in FY24 to Rs 2.43 Lakh Crore?

Flows, increased involvement from individual investors, and positive market conditions have increased the assets of the small-cap mutual fund category to Rs 2.43 lakh crore by the end of March 2024, an 83 percent increase over the same period the previous year.

The spike in assets was accompanied by a rise in investors; in March 2024, there were 1.9 crore folios, up from 1.09 crore the previous year, meaning that 81 lakh new investors joined the investor pool. This demonstrates the preference of investors for small-cap funds.

According to Gopal Kavalireddi, Vice President of Research at FYERS, the development trajectory of the Indian economy is drawing more attention, prompting a large number of unlisted small-cap companies to go to the capital market for assistance. For investors considering chances for long-term development, this trend presents favorable options.

But he also said that variables like the general elections, monsoon predictions, economic activity, inflation, GDP estimates, and FY25 profit growth are probably going to affect the values of small-cap companies and create volatility in this market.

Small-cap funds received an inflow of Rs 40,188 crore in the fiscal year 2023–2024, which was much more than the Rs 22,103 crore received in the previous fiscal year.

But for the first time in more than two years, small-cap funds had a net outflow in March, totaling Rs 94 crore.

This followed after mutual fund firms were instructed by markets regulator Sebi to set up a framework to protect the interests of investors who invested in small and mid-cap funds in late February because of concerns over foam accumulation in these funds.

The worries were raised against the background of the recent quarter’s massive inflow into mutual fund small- and mid-cap schemes.

The asset under management (AUM) of small-cap mutual funds reached a height of Rs 2.43 lakh crore at the end of March 2023, up from Rs 1.33 lakh crore in March 2022, according to statistics from the Association of Mutual Funds in India (AMFI).

The enormous increase in assets was attributed by Kavalireddi to a number of causes, including appealing returns, an optimistic investor attitude, portfolio diversification, and an increase in retail involvement.

Jay Shah, the founder and CEO of Finwisor, said, “The smallcap index itself has grown 60% in FY24, accounting for the majority of the growth in AUM.”

Also, a major element pushing higher allocations to small-cap funds has been the optimistic attitude that investors now have, which has been reinforced by robust economic growth and earnings development.

Furthermore, small-cap funds were popular as a desirable component of diversified portfolios due to their potential for notable growth and undervaluation, as was shown in FY23 during the surge in stock investing.

Due to significant inflows and mark-to-market gains, the total assets under management (AUM) of equity-oriented mutual fund categories increased by 55% to Rs 23.50 lakh crore in the fiscal year 2024. Net inflows for the category increased to Rs 1.84 lakh crore in FY24 from Rs 1.47 lakh crore in the prior fiscal year.

Fund managers in small-cap mutual funds must allocate at least 65% of their portfolios to small-cap companies in accordance with Sebi regulations.

Finwisor’s Shah said, “Smallcap returns have not only been an outcome of market sentiment but also fantastic earnings growth,” as he looked forward to FY25. But in the past, it has been noted that high returns are often followed by poor returns. The chance of zero to low returns is thus greatest for FY25.

While small-cap funds seem like attractive options for growth, they are characterized by high volatility, little liquidity, erratic market risks, and scant research coverage.

Thus, before considering investments in this category, industry professionals advised investors to carefully evaluate their risk tolerance and investment horizon.