Small-cap mutual funds primarily invest in companies with a market capitalisation of less than ₹5,000 crores. These funds focus mainly on small-cap stocks, with only a small portion invested in larger market categories. Although small-cap funds have the potential to outperform large- and mid-cap funds, they also carry significantly higher risk. To understand them better and explore suitable options, you can review some of the best small-cap mutual funds to invest in for 2025.

1. Investors Seeking Diversification:
   Suitable for those already investing and looking to diversify their portfolio. Since small-cap funds are risky, they help spread investments across different categories rather than relying only on small-cap stocks.
2. High Risk Appetite / Aggressive Investors:
   Small-cap funds carry higher risk compared to mid- or large-cap funds as they invest in smaller, growing companies. They are ideal for investors willing to handle sharp fluctuations and potential short-term losses.
3. Long-Term Investors:
   These funds may experience sudden short-term volatility but generally perform well over longer periods, making them suitable for investors who can stay invested for the long term.

Risk Factor:

Small-cap mutual funds are much more volatile than mid- or large-cap funds, and their NAVs tend to fluctuate widely. This makes them a high-risk investment option.

Investor Expertise:

These funds can deliver strong performance when managed with the right strategy and close monitoring. However, due to their high volatility, they are recommended for investors who have good experience and understanding of mutual fund investing.

Investment Term:

Small-cap mutual funds are best suited for investors with a long-term investment horizon. They are generally not ideal for those looking to invest for a short period.

1. High Growth Potential:
   Small-cap funds have significant growth potential because small-cap companies often follow aggressive expansion strategies, which can lead to substantial long-term growth.
2. Ability to Outperform Other Equity Funds:
   When large-cap or mid-cap funds underperform, small-cap mutual funds can provide better returns, making them a valuable addition to diversify and balance a portfolio.
3. Researched Diversification:
   The best small-cap funds invest in companies with strong growth potential based on extensive research by fund managers. This approach allows investors to diversify their portfolio while taking calculated risks.

High Volatility:

Small-cap funds are highly volatile, with prices that can fluctuate dramatically. This makes them unstable, and investors may face substantial losses if market movements do not align with expectations.

Risky Performance:

The performance of small-cap funds depends on multiple factors, including stock selection, individual stock performance, and timely intervention by the fund manager. Due to these variables, returns may not always meet investor expectations.

Low Liquidity:

Small-cap funds often have limited participation from both institutional and retail investors, leading to potential liquidity issues. This can make it difficult to buy or sell units at the desired price.