Definition of a Small-Cap Fund

A small-cap fund is a mutual fund or exchange-traded fund (ETF) that primarily invests in companies with a market capitalization between $300 million and $2 billion. These funds focus on high-growth potential businesses, often in emerging industries, that may develop into mid or large-cap firms.

For example, a Canadian small-cap fund might invest in technology startups, healthcare innovators, or energy firms with strong expansion potential.

Purpose of Small-Cap Funds in Investment Portfolios

Small-cap funds serve several investment objectives:

• Growth potential by investing in companies with higher revenue expansion.
• Diversification by spreading risk across multiple small-cap stocks.
• Long-term appreciation as small-cap stocks may grow into mid or large-cap companies.
• Active and passive management options depending on investment preference.
• Access to undervalued stocks that are not widely followed by analysts.

Types of Small-Cap Funds

Actively Managed Small-Cap Funds

• A fund manager selects stocks based on research and market trends.
• Example: A Canadian small-cap growth fund focuses on tech startups with high earnings potential.

Passive Small-Cap Funds (Index Funds & ETFs)

• These funds track small-cap stock indices and require less management.
• Example: A TSX Small Cap ETF mirrors the performance of small Canadian companies.

Growth vs. Value Small-Cap Funds

• Growth funds target companies with rapid revenue expansion.
• Value funds invest in undervalued small-cap stocks that are expected to rise in price.
• Example: A biotech small-cap growth fund vs. a small-cap industrial value fund.

Small-Cap Funds vs. Large-Cap Funds

Feature	Small-Cap Fund	Large-Cap Fund
Market Capitalization	$300M - $2B	Over $10B
Growth Potential	High	Moderate to low
Volatility	High	Low
Risk Level	Higher	Lower
Liquidity	Lower	Higher

Example: A small-cap fund investing in emerging AI startups carries more risk but offers higher potential returns compared to a large-cap blue-chip fund.

Advantages and Disadvantages of Small-Cap Funds

Advantages

• Potential for higher returns as small-cap stocks often outperform large-cap stocks over time.
• Diversification by investing in multiple small-cap stocks reducing the risk of a single company's failure.
• Early investment opportunities as many small-cap companies later grow into mid- or large-cap firms.

Disadvantages

• Higher volatility due to more frequent price fluctuations compared to large-cap stocks.
• Lower liquidity as small-cap stocks may be harder to sell quickly.
• Greater risk because these companies may be more vulnerable to economic downturns.

Related Terms

• Market capitalization – The total market value of a company’s outstanding shares.
• Index fund – A type of passive investment that tracks a stock index.
• Mutual fund – A professionally managed portfolio of stocks, bonds, or other assets.

Interesting Fact

Over the past several decades, despite higher volatility, small-cap stocks have historically outperformed large-cap stocks in terms of average annual returns.

Statistic

According to Morningstar, more than 20 percent of Canadian investors allocate a portion of their portfolio to small-cap funds, seeking higher returns despite increased risk.

Frequently Asked Questions (FAQ)

1. Are small-cap funds riskier than large-cap funds?

Yes, small-cap funds carry higher volatility and risk, but they also offer greater growth potential.

2. How can I invest in small-cap funds?

Investors can buy small-cap funds through mutual funds, ETFs, and stock exchanges.

3. Do small-cap funds pay dividends?

Some small-cap funds offer dividends, but most reinvest profits for growth.

4. Are small-cap funds good for long-term investing?

Yes, long-term investors with a higher risk tolerance can benefit from small-cap growth.

5. What sectors have the most small-cap stocks?

Industries like technology, healthcare, energy, and consumer goods have a high number of small-cap companies.