Why try to time the market when time in the market works better? History shows that patient investors who stay the course often walk away with the real rewards, says Ramalingam Kalirajan
Feeling anxious about your small-cap fund investments? You're not alone.
With the recent 25% drop in the small-cap indices, many investors are wondering if it is time to pull out or hold on for long-term gains?
Small-cap investors are facing a grey, stormy season.
More than half of the small-cap stocks are down by 50 per cent or more from their all-time highs.
Add to this the sentiment of veteran investors who are calling small caps 'expensive' and urging that such SIPs be stopped entirely.
Should you bail out or double down?
Small-cap funds have taken a beating but that doesn't mean they're finished.
In this article, we explore whether exiting now is wise or if holding tight might offer better long-term rewards.
1. The current state of the small-cap market
Let's understand the numbers before jumping to conclusions:
- Small-cap index is down 25%+ from recent highs.
- Over 55% of small-cap stocks have fallen more than 50% from their peak.
- Market-cap-to-PAT ratio is 50% above the historical median.
- Current P/E ratio of small-cap space is 31.3x, still inflated.
Historical froth example: In FY18, the BSE 250 SmallCap Index touched a P/E of 86 while actively managed funds maintained a more conservative 28.
Key takeaway? The space remains overheated, even post-correction.
Are we truly seeing value here or just a slightly deflated bubble?
2. Why are investors exiting small-cap funds now?
Much like fans turning against a cricket star during a lean patch, many investors are giving up on small caps.
Panic makes sense when returns dry up, volatility soars and market experts voice concerns.
But ask yourself -- is reacting to fear more profitable than responding to data?
When red dominates your portfolio, it's easy to lose sight of your original goals.
Behavioural biases like loss aversion kick in hard.
Are you reacting to short-term discomfort or responding with long-term strategy?
3. Reasons to exit small-cap funds during market corrections
a) Unrealistic return expectations
The excitement of a high-return year often fuels greed.
| Metric | Value |
|---|---|
| 1 year return (December 2024) | 35% |
| 3 year return | 23% |
But history warns us:
- When annual returns cross 30%, there's a 60% chance of less than 10% return the next year.
- There's also a 26% chance of negative returns.
Is this optimism or overconfidence?
When future returns disappoint after a golden run, disappointment quickly turns into mass redemptions.
Investors often forget: Outsized returns come with outsized risk.
b) Long and painful recoveries
The post-COVID market recovery spoiled many investors. Are we now expecting every dip to be followed by a swift rebound? That's wishful thinking.
Not all recoveries are sharp and swift, especially in the world of small-cap funds.
Take the 2008 global financial crisis for example. The worst-performing small-cap fund delivered zero returns for more than six years. Even more recently, during the 2018-2020 small- and mid-cap slump, these funds went nowhere for over two-and-a-half years.
The lesson? Patience isn't just a virtue in small caps; it's a necessity.
c) Liquidity challenges
Selling small-cap stocks during a downturn is like trying to exit a cinema hall through a narrow door during a fire.
Top small-cap funds need 36 days to liquidate half their portfolio.
Mid-cap funds need only 17 days.
When redemptions spike, fund managers are forced to sell illiquid stocks at low prices, dragging down NAVs.
Are you prepared for this impact?
4. Why staying invested in small-cap funds might be smarter
a) Long-term growth potential
History has shown that small caps reward the patient.
Example: An investor who started an SIP in 2017, just before the 2018 crash, is enjoying 19% annualised returns today.
Would you rather quit during a storm or sail through and reach your destination?
Small caps, though volatile, are where emerging giants are born.
If you want above-average returns, shouldn't you be ready for above-average volatility too?
b) Mutual funds vs direct stocks: Who wins?
Investing in individual small-cap stocks? That's like playing darts blindfolded.
- Only 11% of small caps graduate to mid/large caps.
- 62% fall into micro-cap space with just 2% CAGR.
Compare that with small-cap mutual funds:
- Even the lowest-ranked fund delivered 12.74% SIP return over 10 years as on April 22, 2024.
Behind the scenes: Fund managers screen 4000+ companies, narrow it down to 600+ and invest in just 500+ quality picks. It's a science, not a gamble.
Would you rather bet on a lottery or trust a team with data, processes and experience?
c) Volatility reduces over time
Even in the worst-case scenario, staying invested helps smooth out returns.
Average small-cap fund: Max vs min annual returns (based on daily rolling returns since 2006)
| Investment Period | Max Returns (%) | Min Returns (%) |
|---|---|---|
| 1 Year | 138.1 | -61.3 |
| 3 Years | 41.6 | -16.5 |
| 5 Years | 31.9 | -2.9 |
| 7 Years | 28.1 | 4.4 |
| 10 Years | 28.2 | 7.4 |
| 12 Years | 22.7 | 6.5 |
Short-term returns can feel like a rollercoaster but does that mean you should jump off mid-ride? For small-cap funds, volatility is par for the course. Yet, as the investment horizon lengthens, the ride smooths out.
Why try to time the market when time in the market works better? History shows that patient investors who stay the course often walk away with real rewards.
The longer you stay invested, the lower the odds of loss. SIPs held for 7+ years in small-cap funds have rarely ended in red.
d) History rewards the brave
After every negative year in small caps, there's an 88% chance that the next five years deliver greater than 10% CAGR.
This isn't just data, it's a story told by every long-term investor who held on.
Wouldn't it be wise to let history be your compass?
5. What should you do if your small-cap fund is in loss?
There's no one-size-fits-all answer.
Consider exiting if:
- You have a short-term goal (less than five years).
- You can't tolerate when the value of your investment falls steeply (deep drawdowns).
- Market volatility affects your peace of mind.
Consider staying if:
- You have a 7-10 year horizon.
- You're comfortable with risk.
- You're investing through SIPs and avoiding lump-sum bets.
Ask yourself: Is your portfolio built to weather storms or chase sunshine?
6. What should investors do now? A practical action plan
Let's not stop at theory. Here's a practical roadmap:
- Review your goals: Are they long-term? Then short-term corrections are noise.
- Check your asset allocation: Overweight in small caps? Rebalance.
Ramalingam Kalirajan, an MBA in finance, is a certified financial planner. He is the director and chief financial planner at Holistic Investment Planners, a leading financial planning and wealth management company.
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