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What is a Small Cap Equity Fund?

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  • Written By: Dana DeCecco
  • Edited By: A. Joseph
  • Last Modified Date: 23 September 2016
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A small cap equity fund is a mutual fund or an exchange-traded fund (ETF) that is composed of a group of small cap stocks. The term "small cap" refers to a stock with a relatively small market capitalization. The term differs among brokers but as of 2011, it typically referred to a market cap of $300 million US Dollars to $2 billion USD. Market capitalization is simply the total of outstanding shares times the price per share. A small cap equity fund can be designed for a variety of investment objectives.

Equity fund managers provide an overview of investment objectives and strategy. They might focus on income through value stocks or capital gains through growth stocks. Funds can be international or specific to a country or region. A small cap equity fund might concentrate on a particular economic sector or industry. Some equity funds allocate a percentage of funds to small cap companies and the remainder to other investments.

One advantage of investing in a small cap equity fund as opposed to buying individual stocks is diversification. Investing in a group of companies helps to mitigate risk. Another advantage is the potential for growth. Smaller companies are flexible and adaptable, which enables them to quickly take advantage of changing market conditions. Small cap growth funds could experience dramatic capital gains.

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The disadvantage of small cap investing is the greater risk inherent with smaller, unestablished companies. Small cap companies tend to be aggressive and volatile. Dividends are not typically paid because profits are reinvested to fuel rapid growth. The investor in small cap stocks must have the risk appetite for price volatility and the lack of dividends. Studies have shown, however, that shareholders in smaller companies consistently earn greater returns than investors in larger large companies.

Small cap index funds are passively managed funds composed of all the small cap stocks within an index. An actively managed fund will hand-pick the companies within the fund. Equity fund managers are paid to actively manage funds, which includes implementing strategies and interacting with investors. A good fund manager will closely monitor market conditions and suggest when to buy or sell particular stocks.

A balanced small cap fund provides exposure to small cap companies while balancing risk through the use of other securities. This type of fund might use bonds to produce income or options to hedge risk. Micro cap funds are a market niche that might be somewhat risky. At one time, nearly all companies were micro caps, even many of the largest corporations. A good micro cap fund has a top-notch management team that is able to spot future industry leaders.

The investor interested in a small cap equity fund has access to plenty of advise and research. Most investors do not have the time or expertise to research all of the small cap stocks and select the best companies. Professional advisors, investment banks and brokers provide analysis and reports concerning investments in small cap equity funds.

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