If you’re looking to grow your wealth in the long term, small cap mutual funds can be a smart investment option in 2025. These funds invest in small-sized companies that have the potential to become future market leaders. While small cap funds come with higher risk, they also offer higher growth opportunities compared to large or mid cap funds. With India’s economy on the rise and more investors turning to equities, choosing the right small cap mutual funds can help you achieve significant returns. In this article, we’ve handpicked the best small cap mutual funds in India for 2025 that can deliver strong performance and help you build wealth over time.
Best Small Cap Mutual Funds in India 2025
| Fund Name | AUM | 3Y Return | 1Y Return | Expense Ratio | Rating | Risk |
|---|---|---|---|---|---|---|
| Quant Small Cap Fund Direct Growth | ₹25183 Cr | 21.72% | -8.38% | 0.68% | ⭐⭐⭐⭐⭐ | Very High |
| Bandhan Small Cap Fund Direct Growth | ₹9236 Cr | 25.2% | 9.71% | 0.45% | ⭐⭐⭐⭐⭐ | Very High |
| Nippon India Small Cap Fund Direct Plan | ₹57010 Cr | 21.28% | -1.4% | 0.7% | ⭐⭐⭐⭐⭐ | Very High |
| Bank of India Small Cap Fund Direct Growth | ₹1556 Cr | 16.95% | 1.2% | 0.48% | ⭐⭐⭐⭐ | Very High |
| Tata Small Cap Fund Direct Growth | ₹8883 Cr | 21.07% | 2.98% | 0.36% | ⭐⭐⭐⭐ | Very High |
| Edelweiss Small Cap Fund Direct Growth | ₹4171 Cr | 18.07% | 0.58% | 0.4% | ⭐⭐⭐⭐ | Very High |
| Canara Robeco Small Cap Fund Direct Growth | ₹11528 Cr | 14.4% | -2.5% | 0.51% | ⭐⭐⭐⭐ | Very High |
| HSBC Small Cap Fund Direct Growth | ₹15453 Cr | 17.36% | -4.85% | 0.67% | ⭐⭐⭐⭐ | Very High |
| HDFC Small Cap Fund Direct Growth Option | ₹31230 Cr | 19.12% | -4.87% | 0.77% | ⭐⭐⭐ | Very High |
| Invesco India Smallcap Fund Direct Growth | ₹5905 Cr | 21.87% | 5.75% | 0.41% | ⭐⭐⭐⭐ | Very High |
What is Small Cap Mutual Funds?
Small Cap Mutual Funds are a type of equity mutual fund that primarily invests in stocks of small-sized companies with a market capitalization of less than ₹5,000 crore. These companies are typically ranked below the top 250 companies in terms of market capitalization.
Small cap companies are often less known brands and operate in niche sectors, making them high-risk but high-growth potential investments. While these funds have the ability to generate extraordinary returns over the long term, they are also more volatile and sensitive to market fluctuations.
Investing in Small Cap Mutual Funds requires patience and a high-risk appetite, as the short-term performance of these funds can be unpredictable. However, for investors with a long-term horizon, these funds can provide significant wealth creation opportunities as small companies grow into larger businesses.
How Do Small Cap Mutual Funds Work?
Small Cap Mutual Funds work by pooling money from multiple investors and investing primarily in small-cap companies listed on the stock exchange. These companies usually have a market capitalization of less than ₹5,000 crore and rank below 250 in the market cap list.
The fund manager carefully selects stocks of emerging businesses that have the potential for high growth in the future. These companies are often in their early stages of growth, offering investors an opportunity to earn higher returns if the company performs well.
However, small-cap stocks are more volatile compared to large or mid-cap stocks. During market fluctuations, these stocks may face sharp price movements, making small-cap funds a high-risk, high-reward investment option.
Who Should Invest in Small Cap Funds?
Small Cap Mutual Funds can be an attractive investment option for certain types of investors, but they are not suitable for everyone due to their high-risk and high-reward nature. Investing in small cap funds requires a clear understanding of the risks involved and a strong financial plan. Here’s a detailed look at who should invest in small cap funds:
Investors with High-Risk Appetite
Small Cap Mutual Funds are known for their volatile nature. The share prices of small companies can fluctuate significantly in a short period. If you are someone who can tolerate market ups and downs without panicking, small cap funds can be a suitable option for you. These funds have the potential to deliver multi-bagger returns over the long term, but they can also witness sharp corrections during market downturns.
Long-Term Investors (Minimum 7-10 Years)
Small cap stocks take time to grow and unlock their full potential. Therefore, investors who are looking for long-term wealth creation should consider investing in small cap funds. The longer you stay invested, the higher the chances of earning consistent and better returns.
A long-term horizon helps to average out market volatility and allows small companies to grow into mid-cap or large-cap companies, boosting the fund’s returns.
Investors Looking for Higher Returns
Small cap funds have the ability to generate much higher returns compared to large cap or mid cap funds, especially during a bull market. If your primary goal is to achieve higher-than-average returns and you are ready to take the accompanying risks, small cap funds can be a perfect choice.
However, it’s important to understand that higher returns come with higher risks.
Diversified Portfolio Seekers
If you already have investments in large cap and mid cap funds, adding small cap funds to your portfolio can help in diversifying your risk. Small cap funds can act as a growth booster in your investment portfolio, especially during market rallies.
A well-diversified portfolio that includes large cap, mid cap, and small cap funds helps to balance risk and return.
Experienced Investors
Small cap funds are not recommended for first-time or beginner investors. These funds require a deep understanding of market cycles, company fundamentals, and patience to hold through market volatility. Experienced investors who have been investing in mutual funds or equities for a while can handle the risks associated with small cap funds more effectively.
Investors with SIP Mindset
Systematic Investment Plans (SIP) work well with small cap funds. By investing small amounts regularly, you can benefit from rupee cost averaging and reduce the impact of market volatility. SIPs help investors to stay disciplined and make the most of market corrections without worrying about timing the market.
Investors with Surplus Funds
Since small cap funds are high-risk investments, it is advisable to invest only your surplus funds or money that you don’t need in the near future. Avoid putting your emergency funds or short-term savings into small cap mutual funds.
Who Should Avoid Small Cap Funds?
- Investors with a low-risk appetite
- People looking for stable or regular income
- Those with short-term financial goals (1-3 years)
- Beginners with no prior market knowledge
Taxation on Small Cap Funds
Taxation plays a significant role in determining the overall returns from Small Cap Mutual Funds. The profits earned from small cap fund investments are subject to capital gains tax, which depends on the investment holding period.
Since small cap mutual funds predominantly invest in equity stocks, their taxation follows the same rules as equity-oriented mutual funds. To maximize your mutual fund returns and save on taxes, check out our Tax Planning Tips guide for smart strategies and better financial planning.
Understanding the Holding Period
The tax treatment of small cap funds is based on how long the investor holds the fund units before redeeming them. This duration is called the holding period, which is divided into two types:
- Short-Term Capital Gains (STCG): If the units are redeemed within 1 year (12 months) of investment, the profit earned is categorized as short-term capital gains.
- Long-Term Capital Gains (LTCG): If the investment is held for more than 1 year, the profit is considered long-term capital gains.
Taxation on Short-Term Capital Gains (STCG)
If you sell your small cap fund units within 12 months of investment, the capital gains will be classified as short-term capital gains. The tax rate applicable on STCG is 15% of the profit earned, irrespective of your income tax slab.
Example: If you invested ₹1 lakh in a small cap mutual fund and redeemed it after 10 months for ₹1.2 lakh, your capital gain of ₹20,000 will be taxed at 15%.
Taxation on Long-Term Capital Gains (LTCG)
If you stay invested in small cap mutual funds for more than 1 year, the gains will be considered as long-term capital gains. According to current tax rules:
- LTCG up to ₹1 lakh per financial year is tax-free.
- Any LTCG exceeding ₹1 lakh is taxed at 10% without indexation benefit.
Example: If you earn ₹1.5 lakh in long-term capital gains in a financial year, the first ₹1 lakh will be exempt, and the remaining ₹50,000 will be taxed at 10%, resulting in a tax of ₹5,000.
Dividend Taxation
If you invest in small cap funds with the dividend option, the dividends received are added to your total income and taxed as per your income tax slab rate. Most investors nowadays prefer the Growth option over Dividend options to avoid frequent tax implications.
Important Tax Planning Tips
- Opt for Systematic Investment Plans (SIP) to spread out your investment and avoid lump sum tax burden.
- Hold your investments for more than 1 year to benefit from tax-free LTCG up to ₹1 lakh.
- Use small cap funds for long-term wealth creation rather than short-term profits.
Small Cap Mutual Funds can be a powerful wealth creation tool if used correctly by the right type of investor. They are best suited for aggressive investors with a long-term horizon, high-risk appetite, and surplus funds.
However, due to their volatile nature, it’s essential to invest only a portion of your portfolio in small cap funds. Proper research, patience, and a diversified approach are key to maximizing returns from small cap funds.
If you are someone who is looking to build long-term wealth and can tolerate short-term market fluctuations, small cap mutual funds can be a great addition to your investment journey.