Nippon India Small Cap vs HDFC Small Cap Fund: A Smart Investment or a Risk Trap?

Mutual Funds

The Indian small-cap universe has been on a roller-coaster ride since 2024. Following an incredible bull phase in the first half of the year, in which small-cap stocks gained substantial returns and witnessed enormous inflows, the script got turned around quite abruptly. A sharp correction in the second half of the year has left everyone wondering if they missed the bus.

This boom-and-bust phenomenon has once again brought valuation risks, liquidity issues, and the viability of small-cap rallies to the forefront. Those who flocked in at the top are now struggling with losses, and experienced market players are looking for bargains on the horizon.

What precipitated this dramatic reversal? Can small-caps rebound, or more agony to come?

At the beginning of 2024, the small-cap stocks continued with their winning run in 2023, fueled by robust economic growth, good corporate earnings, and increasing investor optimism. Phrases like renewable energy, infrastructure, pharma, and tech did well. The Modi 3.0 budget (July 2024) was emphasised on infrastructure, digitalisation, and manufacturing and boosted small-cap confidence even further.

However, small-cap stocks faced a sharp downturn in the latter half of 2024. Several factors triggered the correction – overvalued small-cap stocks faced profit booking by institutions, while SEBI’s risk advisory led to a sentiment shift. Rising U.S. rates, geopolitical tensions, and slowing global growth hit investor confidence. FIIs exited emerging markets, causing a liquidity crunch, and retail investors, shaken by corrections, began exiting, deepening the downturn.

[Read: Small Cap Index Has Corrected. Good Time to Invest in Small Cap Funds Now?]

Even after the recent correction, the long-term scenario for Indian small-cap shares continues to look upbeat. Although, a complete recovery will be time-consuming, long-term investors may still find value among the small-caps by selecting their bets very carefully and staying with fundamentally healthy companies.

That being said, investors need to review their holdings and decide if their small-cap fund is consistent with their risk tolerance. Not all small-cap funds are created equal-some make aggressive bets on upstart companies, while others invest in relatively stable, high-quality businesses.

Comparison between small-cap funds can assist investors in determining the extent of risk exposure in their portfolios. Those funds with heavy exposure to illiquid, speculative stocks or funds that have experienced severe drawdowns during corrections in the market could be more risky.

Conversely, funds that have diversified portfolios of strong fundamental small-cap stocks could be appropriate for weathering the storms of the market.

Investors can use this comparison to decide if they need to remain invested, rebalance, or shift to a suitable alternate fund that aligns with their investment objectives.

Keeping this in view, here’s a thorough analysis of two of the best small-cap funds that have delivered superior returns during various market cycles.

# – Nippon India Small Cap Fund

Started in September 2010, the scheme currently has a strong AUM of Rs 50,826 crores. It follows a growth and diversified approach, investing in high-growth small-cap stocks across sectors. And is early-stage concentrated, identifying businesses with good fundamentals and scalable models, eschewing concentration risk while benefiting from sectoral growth.

# – HDFC Small Cap Fund

HDFC Small Cap Fund has a value and quality-focused strategy with an emphasis on well-functioning companies with high return ratios and stable cash flows.

In contrast to Nippon India Small Cap Fund, HDFC Small Cap Fund is more inclined towards IT and healthcare industries, reflecting a bias towards defensive but high-growth areas. This strategy aids in controlling downside risk while preserving long-term capital appreciation.

Performance Comparison: Rolling Returns

Scheme Name	Absolute (%)		CAGR (%)
Scheme Name	6 Months	1 Year	3 Years	5 Years	7 Years	10 Years
Nippon India Small Cap Fund	12.96	40.73	30.28	35.33	23.20	24.51
HDFC Small Cap Fund	9.33	31.01	25.61	28.61	19.85	20.62
Category Average – Small Cap Funds	11.76	34.44	24.75	31.10	19.18	20.08
Benchmark – Nifty Small Cap 250 TRI	11.86	42.27	24.30	29.06	15.67	16.89

Data as of February 28, 2025
Do note past performance is not an indicator of future returns
The securities quoted are for illustration only and are not recommendatory.
(Source: ACE MF, data collated by PersonalFN Research)

As can be observed, Nippon India Small Cap Fund has surpassed its counterpart, the HDFC Small Cap Fund, for all time horizons, posting greater absolute and CAGR returns. It has also performed well compared to category average and benchmark returns.

Nippon India Small Cap Fund has been a consistent performer with 3-year (30.28%), 5-year (35.33%), and 7-year (23.20%) CAGR returns outperforming HDFC Small Cap Fund as well as the category average. HDFC Small Cap Fund, on its part, has also produced good returns of 25.61% (3 years), 28.61% (5 years), and 19.85% (7 years)-all better than the category average. Though Nippon India Small Cap Fund is the better performer, HDFC Small Cap Fund is stable in the long term and a sure bet for small-cap investors. Both of them beat the Nifty Small Cap 250 TRI benchmark, presenting robust portfolio strategies.

While assessing small-cap funds, it is very important to keep a long-term performance focus in mind. While short-term fluctuation is always natural, long-term history demonstrates that small-cap funds generally perform better over a long horizon of time. Nippon India Small Cap Fund and HDFC Small Cap Fund have also been reflecting good long-term performance with 10-year CAGR return of 24.51% and 20.62%, respectively, substantially beating the benchmark (16.89%).

This supports the notion that small-cap investments need patience, as their growth narrative is played out over several market cycles, finally rewarding investors who remain invested for the long term.

[Read: 5 Small Cap Funds Down by Over 10% in the Recent Market Correction]

Portfolio Composition: Asset Allocation of Schemes

Scheme Name	Large Cap %	Mid Cap %	Small Cap %
HDFC Small Cap Fund	4.04	8.60	80.00
Nippon India Small Cap Fund	12.04	14.78	67.13

HDFC Small Cap Fund has a greater exposure to small-cap stocks at 80%, which makes it more aggressive and in line with pure small-cap investing. It exposes itself minimally to the large caps (4.04%) and the mid-caps (8.60%), suggesting that the fund bares high growth-oriented small-cap firms and stable large firms.

On the other hand, Nippon India Small Cap Fund follows a more diversified approach by investing 67.13% in small caps, less than that of HDFC (80%). It invests a larger chunk in mid-cap stocks (14.78%) and large caps (12.04%), providing a greater balance between high growth ability and stability.

This makes Nippon India Small Cap Fund relatively less risky than HDFC Small Cap Fund since higher exposure to mid and large caps can act as a cushion in case of market fall. Risk-reward-seeking investors might prefer HDFC Small Cap Fund, whereas risk-reward moderate investors might opt for Nippon India Small Cap Fund.

Market Volatility: Risk Profile of Schemes

Risk Ratio	HDFC Small Cap Fund	Nippon India Small Cap Fund
Standard Deviation (3 Year)	17.03	18.30
Sharpe	0.24	0.26
Sortino	0.42	0.46

Standard Deviation quantifies the volatility, and the bigger the number, the higher the volatility of fluctuating returns. It can be seen that both funds have high volatility, as would be the case in the small-cap universe.

Yet, Nippon India Small Cap Fund has a higher Standard Deviation (18.30 vs. 17.03) over the last three years, suggesting that its returns have been more volatile than HDFC Small Cap Fund. This implies that investors in Nippon India Small Cap Fund might face sharper movement in returns, and thus, it is riskier.

On a risk-adjusted basis, Nippon India Small Cap Fund has a slight advantage too. Its Sharpe Ratio (0.26 vs 0.24) and Sortino Ratio (0.46 vs 0.42) are higher by a slim margin compared to HDFC Small Cap Fund, which means that it has generated superior returns per unit of risk incurred.

Although both funds are highly risky, Nippon India Small Cap Fund seems to provide a marginally better risk-reward trade-off, while HDFC Small Cap Fund offers comparatively greater stability in returns.

Top Holdings of the Schemes:

Nippon India Small Cap Fund		HDFC Small Cap Fund
Company	% Assets	Company	% Assets
HDFC Bank Ltd.	2.27	Firstsource Solutions Ltd.	6.75
Multi Commodity Exchange Of India Ltd.	1.82	eClerx Services Ltd.	3.77
Kirloskar Brothers Ltd.	1.40	Aster DM Healthcare Ltd.	3.49
Dixon Technologies (India) Ltd.	1.29	Bank Of Baroda	3.28
Karur Vysya Bank Ltd.	1.26	Fortis Healthcare Ltd.	2.71
State Bank Of India	1.23	Eris Lifesciences Ltd.	2.51
Tube Investments of India Ltd.	1.21	Sonata Software Ltd.	2.16
NLC India Ltd.	1.11	Krishna Institute of Medical Sciences Ltd	2.12
AWL Agri Business Ltd.	1.09	Gabriel India Ltd.	1.99
Apar Industries Ltd.	1.03	Sudarshan Chemical Industries Ltd.	1.76

Nippon India Small Cap Fund has a diversified portfolio of companies in financials, industrials, and manufacturing. Its largest holding, HDFC Bank (2.27%), indicates a concentration on well-established financial institutions, followed by Multi Commodity Exchange of India (1.82%), a market leader in commodity trading.

Conversely, the HDFC Small Cap Fund has a strong bias towards IT, healthcare, and banking. Its largest holding, Firstsource Solutions (6.75%), indicates a strong inclination towards IT-enabled services, followed by eClerx Services (3.77%), another biggie in the tech outsourcing industry. The fund also has exposures in manufacturing and chemicals like Gabriel India (1.99%) and Sudarshan Chemical Industries (1.76%), which diversify the portfolio.

In summary, while Nippon India Small Cap Fund has a broader multi-sector approach with a significant banking presence, HDFC Small Cap Fund has a stronger leaning towards IT and healthcare and hence is appropriate for varying risk appetites and themes of investment.

Expense Ratio of the Schemes

Scheme Name	Direct Plan Expense Ratio	Regular Plan Expense Ratio
Nippon India Small Cap Fund	0.74%	1.49%
HDFC Small Cap Fund	0.82%	1.60%

As you can see, the Nippon India Small Cap Fund has a significantly lower Expense Ratio for both regular and direct plans as compared to the HDFC Small Cap Fund. Do note even a small percentage point difference in the expense ratio can accumulate over time and impact your returns.

On the contrary, HDFC Small Cap Fund’s significantly higher expense ratio makes Nippon India Small Cap Fund a cost-effective option for many investors.

However, remember that while a lower Expense Ratio can potentially lead to higher returns over time, it should not be the only factor to consider when investing in sectoral funds.

Suitability of Investors to the Schemes:

Nippon India Small Cap Fund is among the largest and most well-established funds in the small-cap category, known for its ability to capture opportunities across market cycles. It may be suitable for investors who are comfortable with higher volatility and are looking for a fund with a consistent track record of navigating small-cap market dynamics.

HDFC Small Cap Fund also follows a high-risk, high-return approach, making it equally suited for investors with a strong risk appetite. While it follows a bottom-up stock-picking strategy and maintains a long-term growth focus, investors must be prepared for periods of underperformance as small-cap stocks tend to be more sensitive to market cycles.

While both funds aim for long-term capital appreciation, investors should assess their risk tolerance, ability to withstand short-term corrections, and investment tenure before choosing between them.

To conclude…

The Indian small-cap segment, despite recent volatility and a market slump, remains a high-growth space backed by strong economic fundamentals and structural reforms. While near-term corrections may continue due to global uncertainties and liquidity concerns, the long-term outlook remains positive, driven by rising domestic consumption, increasing capital expenditure, and digital transformation.

Investors should focus on quality small-cap funds with strong stock-selection strategies, as these companies have the potential to emerge as tomorrow’s industry leaders.

Disclaimer: PersonalFN does not receive any monetary compensation from the fund house or scheme names stated in the article.

This article first appeared on PersonalFN here