Smaller companies tend to react violently to any change of mood. Their stocks are not liquid, and when the time comes to realize your returns, you could again have to wait for a long time to encash your investments. Just as you did when buying into the stock, the selling would also have to be done in meagre numbers m If that isn’t done then again, the impact cost of selling to much stock too quickly would itself depress the price. This is particularly true when markets take a sharp turn downwards.
Whenever the NAV drops sharply, a certain proportion of fund investors tend to redeem their investments in a rush. These redemption’s are precisely what small-cap funds can’t handle at that point. In a general downturn, all these effects-NAV decline, loss of liquidity, impact cost of selling tend to multiply with each other and produce a huge negative impact leading to a great reduction in your returns. Eventually, you will be forced into a debt trap of a personal loan or a credit card loan to finance your requirements, thereby reducing your net worth.
Small-cap investing is an inherently tricky activity. It may be suited only to investors who are knowledgeable, patient and don’t mind paying a percentage game. Even if you, as an investor in a small-cap fund understand the issues involved and are willing to play the long game, your fellow investors are unlikely to do so.