Pros & Cons of Investing in Tata Small Cap Fund

In the year 2024, the Nifty Smallcap 250 - Total Return Index (TRI) clocked an absolute return of 27%, and in the last five years, it has multiplied by 2.7x, delivering a 30% CAGR.

But it is important to note that investing in smallcaps is a high-risk return proposition. These are companies ranking below 250th in terms of market capitalisation.

Smallcaps are smaller than their mid and largecap counterparts, but some hold the potential to be tomorrow's market leaders.

Given the wealth creation potential demonstrated by smallcaps, many investors are inclined to invest in them by way of small cap mutual funds.

The inflows into small cap funds have soared in the last couple of years, as per the AMFI data. In July 2025, inflows into small cap funds jumped 61% (compared to the previous month) to nearly Rs 65 billion (bn).

Small cap funds are mandated to invest at least 65% of their assets in equity and equity-related instruments of small-cap companies.

Given this, they are placed at the higher end of the risk-return spectrum of diversified equity funds. If you are investing in a small cap fund, you need to have a very high-risk appetite and a longer time horizon of 7-10 years.

Moreover, a small cap fund should ideally be a part of your satellite portfolio and not your core portfolio.

Only a small portion of your entire portfolio may be considered for small cap fund allocation (up to 20%), which can potentially boost your portfolio returns and generate alpha (i.e. outperform the benchmark index).

In this editorial, we will take you through the pros and cons of investing in the Tata Small Cap Fund.

This scheme was launched in November 2018, when the smallcap index was in the grip of a bear phase before it ended in March 2020.

Over the years, the Assets Under Management (AUM) of Tata Small Cap Fund has increased, and as of July 2025, it is over Rs 115 billion (bn).

How Does Tata Small Cap Fund Invest Your Money?

As per its mandate, the scheme invests as follows:

• A minimum of 65% of its assets in equity & equity-related instruments of smallcap companies
• Up to 35% in other than smallcaps
• Up to 35% in debt & money market instruments (including units of debt & liquid schemes of Tata Mutual Fund)
• Up to 10% in REITs & InvITs

The scheme does not invest in overseas securities.

When investing, it follows a 'growth at a reasonable price' (GARP) approach for stock picking.

The focus of the Tata Small Cap Fund is on investing in companies that can grow in terms of profitability and cash flows with strong balance sheets, i.e., low debt and high cash flows.

These businesses can surprise the markets over time in terms of earnings, which in turn can lead to a positive change in the valuations.

So, a bottom-up approach is followed, wherein it assesses the valuations and fundamentals of the stocks. It looks at parameters such as management competitiveness, business competitiveness, corporate governance, growth prospects, past track record, etc.

It holds a sector-agnostic, well-diversified portfolio of small-cap and other stocks with a medium to long-term view to derive their full potential gains.

In the last one year, it has consistently held over 80% of its total assets in smallcaps, while midcaps have ranged between 4% to 10%. It does not have any exposure to largecaps.

The other investments are in REITs & InvITs and cash & cash equivalents.

Tata Small Cap Fund's Allocation

As a part of its strategy, the fund also participates in derivative instruments (up to 50% of its net assets) and other hedging products, but in line with its investment objective.

Should investors consider this fund?

In this editorial, let's discuss the pros and cons of investing in the Tata Small Cap Fund.

Pros

#1 Fairly Diversified Portfolio

The fund holds a fairly diversified portfolio of around 50-60 stocks. As per its July 2025 portfolio, it is currently holding 62 stocks, of which 81.8% are smallcaps and 7.4% are in midcaps.

The top 10 stocks comprise 33.1% of the portfolio and include names such as Sudarshan Chemicals (5.8%), Kirloskar Pneumatic (3.5%), and IDFC First Bank (3.5%), among others.

Among the diverse range of sectors, the top 3 are chemicals, healthcare, and capital goods, which comprise 34.43% of the portfolio.

This makes the stock portfolio fairly diversified, avoiding concentration risk, which helps in dealing with market uncertainty.

Moreover, the fund has steered clear of chasing momentum and focuses on investing with a long-term view. In the last one year, its portfolio churn has not exceeded 20%.

Around 10.8% of the current portfolio is held in REITs & InvITs (0.1%) and cash & cash equivalents (9.6%). Since January 2025, the fund has increased its allocation from 4.6% to currently 9.6% perhaps being conscious of valuations.

#2 Decent Performance

Coming from a fund house following a robust investment process & systems, the fund has been a decent performer with its strategy followed.

Over 3 years and 5 years, the fund has delivered a compounded annualised return of 26.1% and 34.8%, respectively, higher than the category average returns and its benchmark, the Nifty Smallcap 250 - TRI.

What's important is that while generating such returns, the fund has been able to keep its risk in check (despite higher allocation to smallcaps) as reflected by the annualised standard deviation (SD) of 15.97. It is evidently lower than the category average and its benchmark index.

Thus, on risk-adjusted returns as well (as denoted by the sharpe and sortino ratios of 0.37 and 0.67, respectively, the fund has been an above-average performer.

In the previous brief bear phase (from 14 January 2020 to 23 March 2020), the fund fell less than the category average and its benchmark. Similarly, in the ongoing bull phase (from 23 March 2020 to date), the fund has fared a tad better.

Scheme Name	Absolute (%)	CAGR (%)		Risk Ratios
	1 Year	3 Years	5 Years	SD Annualised	Sharpe	Sortino
Tata Small Cap Fund	23.8	26.11	34.86	15.97	0.37	0.67
Category Average*	19.06	23.19	33.47	17.04	0.31	0.58
Nifty Smallcap 250 - TRI	19.48	23.21	32.09	18.82	0.31	0.59

Source: ACE MF

Cons

#1 Small Portion of the Corpus Actually Performing

While the fund has showcased a decent performance, an in-depth study shows that only a small portion of its corpus falls in the top quartile. This means certain bets of the fund are not faring well, even though they may be held with conviction.

The latest stress data from AMFI shows that after removing the bottom 20% of the portfolio based on scrip liquidity, the fund would take 35 days for pro-rate liquidation of 50% of its portfolio, and the next 25% of the portfolio would take 18 days. This is a bit high.

#2 Not Many Dividend-Yielding Stocks Held

Within its portfolio of around 50-60 stocks, the fund does not hold many dividend-yielding stocks, which has some bearing on its total returns.

This has been seen since its launch, but it is also because of the very nature of its portfolio - predominantly in smallcaps and midcaps, which do not necessarily pay dividends but usually plough back profits for future growth.

Conclusion

Tata Small Cap Fund has performed consistently well since its inception in November 2018. It has rewarded investors on a risk-adjusted basis.

While the fund has held the portfolio with conviction and is well-diversified, one needs to be mindful that only a portion of its portfolio is actually performing.

In the current market scenario, where the PE of the Nifty Smallcap 250 index is around 32, slightly above the 5-year average of 29, you need to be careful when approaching small cap funds.

Choose a small cap fund (or any mutual fund scheme for that matter) thoughtfully.

A good thing is Tata Small Cap Fund has suspended fresh investments via the lump sum and switch-in mode with effect from July 2023 and now only accepts investments via SIPs and STPs.

Happy investing.

#Table Note : Data as of 12 August 2025
Rolling period returns are calculated using the Direct Plan-Growth option. Returns over 1 year are compounded annualised.
Standard Deviation indicates total risk, while the Sharpe Ratio and Sortino Ratio measure the Risk-Adjusted Return. They are calculated over 3 years, assuming a risk-free rate of 6% p.a.
*All small mutual fund schemes are considered to compute the category average returns.
Please note that this table represents past performance. Past performance is not an indicator of future returns.
The securities quoted are for illustration only and are not recommendatory.
Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.

Disclaimer: This write-up is for information purposes and does not constitute any kind of investment advice or a recommendation to Buy / Hold / Sell a fund. Returns mentioned herein are in no way a guarantee or promise of future returns. As an investor, you need to pick the right fund to meet your financial goals. If you are not sure about your risk appetite, do consult your investment consultant/advisor. Mutual Fund Investments are subject to market risks, read all scheme-related documents carefully. Registration granted by SEBI, Membership of BASL and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.