Small is beautiful. Or so goes the adage. Never was this more relevant for the equity market than now, thanks to the steady advance recorded by a range of small cap stocks. Indeed, investors have lately feted the small cap category, a trend reflected in increased valuations. Small caps, generally blind-sided and frequently marginalised in ordinary times, are now the subject of heated discussion all across the market.

These are no ordinary times for stocks. The mainline indices have charted new peaks, prompting all categories of investors to feel bullish. For the record, the Sensex has crossed the 67000-point mark even as you read this on Monday morning, while the Nifty is a breath away from 20000 points.

The Nifty Smallcap 50 index, at 5150 points on Thursday, is no more than just a short distance away from its 52-week high of 5200 points. And, yes, a number of small cap funds have been able to seize the opportunity presented to them.

The rise in their valuations, however, has led to the inevitable question — is the current inclination about to plateau? Or is this the beginning of a decline, at least a temporary one?

Such posers have encouraged what seems to be the latest line of thought in mutual fund circles: censure attempts to undertake bulk investments in small cap funds.

In fact, leading fund houses have proscribed large subscriptions, allowing only small doses of fresh allocations to enter their fold. Small cap valuations, after all, are said to be in danger. Entry, therefore, must be controlled very strictly.

Are entry limits actually serving the needs of the committed investor in small cap funds? How should he strategise? What can he do in the present circumstances?

Let us try to address these issues one by one. But first, a good, hard look at the rationale and potential of small caps is in order. These stocks, as readers would no doubt agree, are generally under-researched and under-owned. This actually creates scope for re-ratings. Given their potential for creating wealth, astute investors often seek to leverage small caps for the opportunities they create. However, this very rationale hides the risky nature of small caps.

The other compelling point to consider is the sheer diversity in the segment. A large number of sectors can be covered easily in a typical small cap portfolio. In fact, professional fund managers often point out that such diversity can make it relatively easy for them to pick and choose the best stocks. A basket of small caps — inherently risky, yes — can comprise a wide range of businesses.

A case in point is the Nifty Smallcap 50, an index that covers as many as 18 prominent sectors. Among the leading ones in this list are financial services, information technology, capital goods and healthcare.

The index, according to NSE, has generated more than 28 per cent (total return as on June 30) in the past one year. This, it may be mentioned, is actually a major spike of sorts. The 5-year return generated by the index is a little over 7 per cent.

In a scenario such as this, entry limits may not be entirely justified, some quarters point out. Long term investors (that is, those who do not wish to invest directly in stocks) are still willing to place bets on small cap funds. Limits placed on new subscriptions will not be of any relevance for this section. However, short term and speculative bets should be discouraged at the present juncture.

How should you strategise?

If you are a committed investor gungho on small cap funds, you need to ascertain whether systematic investment plans can be initiated and sustained.

If large-scale allocations are forbidden, nothing can be done about it and SIPs are the only logical route to be taken in such a scenario.

The real poser, however, is the one that relates to asset allocation. How much of your holdings should be in small caps? How much should these stocks contribute to your portfolio? This is difficult to state at any juncture, and opinions would naturally differ widely. A “graded” or “tactical” allocation pattern should be maintained nevertheless, it is felt.

A relatively conservative investor may consider up to, say, 20 per cent, while a more aggressive player may go way higher and accommodate 50 per cent or more. There can never be a hard and fast rule on this front.

The matter needs to be determined on the basis of one’s risk appetite. Small cap funds need to be chosen with the help of the usual metrics. The quality of the portfolio is a weighty consideration, and discerning investors would be guided by the key ratios. The central question is whether the portfolio is under stress or otherwise. Investors must assess whether its top holdings have advanced too much in too short a time period.

A balanced approach, or the classic middle path in other words, is also recommended. Proponents of the policy believe that large caps should account for a critical and obvious parcel of one’s overall portfolio, leaving sufficient space for mid caps. The latter, it must be remembered, hold considerable promise as well.

Large and mid-cap should together contribute to a well-rounded 75 per cent. The rest may then be divided among several small cap funds. This would ensure greater diversification. The risks would be somewhat toned down as well.

Tax on MFs

If switching from one scheme to another of the same mutual fund is considered as redemption, then is capital gains tax applicable on the same? Prasanta Chowdhury, Howrah

Switching is the process of shifting investments from one fund to another within the same mutual fund. There would be implications of exit load and also capital gains tax with the latter based on your period of holding. Even switching between options — growth and dividend — would be considered a sale transaction and taxes levied accordingly.

Exemption for seniors

I have income from pension and interest on deposits and senior citizens savings scheme with banks and post office in my name (primary holder) jointly with my spouse. Can I avail of the exemption on the interest earned from SCSS under sec 10(15) (I) of the IT Act with the deductions allowed on interest on deposits under sec 80TTB.

A. Banerjee, email

Section 10(15) offers exemption from income by way of interest, premium on redemption or other payment on securities, bonds, annuity certificates, savings certificates, other certificates issued by the Centre. SCSS is neither bond, annuity or savings certificate. It is a deposit scheme for seniors and, therefore, exemption under this section is not available while arriving at taxable income. SCSS qualifies for deduction u/s 80C but interest earned is taxable.

Commission income

My only income is from agency commission from life insurance policies up to AY 2022-23. This time while using ITR2, I faced problems like entering deduction under 80C and mentioning my landline number. Please guide me to claim refund of tax.

Soumyadeep Mitra, email

You may use ITR 3 to disclose income from commission. Also update your contact number at the income tax profile page before filing return.