Ahmed JaanFor most people who put their money into the stock market, it’s all about finding that sweet spot between growth and patience. Large and mid-cap funds are there for those who just want to see a steady climb up, but there’s another option altogether i.e., microcap mutual funds.
These funds focus on the smallest listed companies that many really don’t know about. The idea is that these companies have the potential to grow into mid-caps or even large-caps. But is the potential reward really worth hanging around for years and taking on the risk? We are going to take a closer look.
What exactly are microcap mutual funds?
Microcap mutual funds are essentially equity funds that invest mainly in the smallest companies in the market, ones that are ranked outside of the top 500 by market capitalisation. To put it another way, these are companies that are still just getting started. They might be smaller and less well-known, but there might be some real gems in there.
They can do well in a bull market, but go down like a stone when the market turns sour
Why investors are drawn to microcap mutual funds
Even though high-risk investing is the norm for these funds, there are reasons why they keep getting more attention. So let us take a closer look at what is driving their popularity.
1. Early access to emerging businesses
Most of the microcaps out there are working in niches that big institutional investors hardly ever notice. These are businesses that might be flying under the radar but could explode in growth over time.
By investing through a fund, everyday investors get access to these under-the-radar opportunities that are usually out of reach when you are picking stocks on your own.
2. The chance to outshine the rest
When markets are booming or the economy is growing, smaller companies tend to grow way faster than their larger counterparts. Historically, well-run microcap funds have shown that they can outperform the broader market during these upswings.
Their holdings get a boost from business expansion and a bump in share price, too. Of course, it is worth keeping in mind that these periods of outperformance usually come with a price to pay – high risk.
3. A safety net for diversification
With direct stock investing, you are mostly on your own when it comes to choosing which companies to put your money in.
Microcap funds change all that by pooling your investments with dozens of other small companies, and you get diversification without the need to do it yourself. Because the fund managers are managing the fund, you don’t have to worry about keeping an eye on every stock.
What investors should be careful about
Microcap investing – it has a lot to offer, but it is definitely not the right fit for everyone. There are some risks and limitations to keep in mind when you invest in mutual funds.
1. Liquidity challenges
Microcap stocks are usually pretty thinly traded. When the market gets a bit challenging or things are looking grim, getting out of a position can be a real headache. This affects funds that invest in that, and the end result is cost.
2. High volatility
Microcaps are super sensitive to whatever is going on in the market – news, economic shifts, company-wide events, etc. One bad quarter of results or a U-turn on some policy can send the price swinging wildly.
3. Long term commitment is a must
The real value of microcap fund investing only really comes out over a seven to ten-year period. That’s how long you need to hang in there to weather the ups and downs of the market and give companies enough room to grow into their potential.
Final thoughts
Microcap mutual funds are small now, but with the potential to grow into the market leaders of tomorrow. They demand patience, discipline, and the ability to tolerate volatility without panic.
For those who can ride the ups and downs and stay on the course long enough, microcap investments can offer some wealth creation opportunities. But let’s be clear: they are a long, hard slog, not some shortcut to easy gains.
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