The Indian Mutual Fund industry consists of around 44 fund houses with each of them offering a galore of equity-oriented funds. As an investor, you only need around 5-7 equity mutual fund schemes across various sub-categories depending on the financial goals you wish to address as well as your risk profile and investment horizon. Therefore, it may be an uphill task for you to select the best mutual funds from the plethora of options available.

Often you may be tempted to take the shortcut route and select the best mutual funds based on its popularity. Some of you may also face the dilemma about whether you should invest in well-known mutual fund schemes, or mid and small-sized schemes, or funds of lesser-known AMCs, which have generated an equivalent or better performance.

[Read: How to Select Top Equity Mutual Funds for Your Portfolio]

You see, many of the top performing mutual funds in the recent years were relatively small in size (see table below). On the other hand, several large-sized funds in various categories have trailed their mid-sized and small-sized peers by a significant margin in the last few years. This includes popular funds like Kotak Flexi Cap Fund, HDFC Flexi Cap Fund, HDFC Top 100 Fund, Aditya Birla SL Frontline Equity Fund, HDFC Mid Cap Opportunities Fund, to name a few.

Table: Top performing schemes on a 3-year return basis

Scheme Name Category AUM (Rs Crore) 3 Year CAGR
Quant Small Cap Fund Small cap Fund 1241 38.25
PGIM India Midcap Opp Fund Mid Cap Fund 3388 38.03
Kotak Small Cap Fund Small cap Fund 6180 37.49
Quant Active Fund Multi Cap Fund 1304 36.07
Axis Small Cap Fund Small cap Fund 7362 35.06
ICICI Pru Smallcap Fund Small cap Fund 3304 33.11
Tata Small Cap Fund Small cap Fund 1721 32.76
PGIM India Flexi Cap Fund Flexi Cap Fund 2706 32.29
Parag Parikh Flexi Cap Fund Flexi Cap Fund 17220 31.69
Quant Mid Cap Fund Mid Cap Fund 205 31.33

AUM as of October 31, 2021
Returns are in CAGR (%) as on November 25, 2021. Direct Plan – Growth Option considered
Source: ACE MF)  

This highlights that certain lesser known funds too are capable of generating big gains for the investors. Some mid- and small-sized funds are well managed and have the potential to deliver superior risk-adjusted returns in line with the popular peers in the category. Unfortunately, these funds are less noticed by investors as they remain undiscovered under the shadow of popular large-sized funds.

Most small-sized funds (having a corpus of less than Rs 5,000 crore) remain undiscovered despite of their remarkable performance in the past because distributors and brokers generally recommend popular large-sized funds. DIY (Do It Yourself) investors too prefer to invest in popular funds to save themselves from the hassle of comparing different schemes on various parameters.

What they fail to recognise is that there are various instances where some lesser known funds have built a successful track record over the long term without taking undue risk.

This is because the relatively smaller size of the corpus helps fund managers to manoeuvre the portfolio with more agility, in line with the changing market conditions, and maintain highly liquid portfolio. Therefore, small-sized funds may be better placed to limit the downside risk during bearish market phases and uncertain market conditions. Large-sized funds do not have such flexibility, particularly if they have substantial allocation to mid-cap and small cap-stocks.

Do note that this does not mean that popular/large-sized schemes will not do well in future. Well-managed funds with sound investment strategies and risk management processes in place can be expected to do well irrespective of the size of its assets under management (AUM). But in the quest of finding best mutual funds for your portfolio, you should not ignore lesser-known schemes.

Why you should not wait for less popular funds to gain traction before investing in it

The best way to benefit from the high potential of small-sized funds is to be able to identify them early before the crowd discovers them. If you start investing in a scheme after it has gained popularity it may be nearing its saturation stage which can affect its future performance. Many a times the fund may even restrict inflows to maintain the focus of the investment objective. Thus, you may miss out on the wealth creation potential of such funds.

That said, not all less popular funds are worthy of your investment. If a scheme has very low corpus of say Rs 500 crore or less despite being in existence for many years, or if it has generated a one-off superior performance, it may be better to ignore it.

So, just like in the case of small-cap stocks, where quality of the management team and growth potential is the key to finding winners, focus on quality of the fund plays a key role in discovering high potential of less popular funds.

This article first appeared on PersonalFN here

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