Some small cap funds reopen, others stay closed: 5 key investor takeaways

As investors kept piling into smallcap funds in recent years, some fund managers had to resort to gating inflows. Valuations got stretched, opportunities became scarce and liquidity was excessive. Several funds turned off the tap completely or put partial restrictions. Now, after a prolonged lull in the broader market, funds have started resurfacing for fresh air.

Open, sesame!

Even as some funds have reopened for investment, a few remain closed. Many others never shut. Nearly three years after it had shut lump sum investment in July 2023, Tata Small Cap Fund re-opened it earlier in April this year. Tata Mutual Fund has indicated that the recent correction has created a window to build positions at more sensible entry points. ICICI Prudential Smallcap Fund, which had closed lump sum in March 2024, re-opened the investment mode this January, citing underperformance in smallcap stocks and de-rating of valuations. With earlier euphoric sentiments subdued, the fund chose to remove barriers to fresh investments.

Others are more circumspect. The Rs.62,000-crore Nippon India Small Cap Fund has kept lump sum investments suspended since July 2023. However, it recently hiked the limit for fresh systematic investment plan (SIP) registrations from Rs.50,000 per instalment to Rs.2 lakh. Even as the fund house acknowledges that the recent volatility has led to better valuations in this space, it remains wary of near-term geopolitical uncertainty. “Systematic investing is one of the tools to manage these sharp market swings, which can be exaggerated in case of small caps,” says Rajesh Jayaraman, Head– Products, Nippon India Mutual Fund.

The Rs.32,000-crore SBI Small Cap Fund has kept lump sum investment closed even six years on, after the window was shut in September 2020. It only admits SIP contributions of up to Rs.25,000 per month, per individual. The fund house had cited capacity constraints in this segment, suggesting that the call to shut gates is not always driven purely by valuations.

The quantum of inflows into a scheme may also guide asset managers’ actions. A fund witnessing higher inflows may find it difficult to absorb the incremental money compared to another experiencing modest inflows. “A Rs.40,000–50,000 crore small-cap fund simply cannot deploy money with the same agility as a Rs.5,000-crore fund without impacting liquidity and return potential,” maintains Rajani Tandale, Senior Vice President–Mutual Fund at 1 Finance.

In such cases, restricting inflows may be a way to protect existing investors’ interests rather than reflect a view on valuations of the segment, insists Manuj Jain, Director & Co-founder, ValueMetrics Technologies. “For already large and popular schemes receiving steady inflows, the opportunity set may not expand proportionately. As a result, fund managers may end up adding new stock names out of compulsion rather than choice, leading to a long tail of holdings.”

Ashok Kumar E.R., Chief Client Officer, Scripbox, says fund managers’ continued gating reflects “prudence and a priority on protecting existing investors’ long-term performance from performance dilution.”

The same fund’s behaviour may vary in times of market excesses, depending on the influx of money. For instance, DSP Small Cap Fund did not restrict inflows during the excesses of 2024. But it had put clamps on inflows in 2016–17. It re-opened only in March 2020 and has not closed for subscription since. “At that point (in 2024), we were not witnessing strong flows into our small-cap fund. Hence, we didn’t see a point in closing,” explains Vinit Sambre, Head– Equities, DSP Mutual Fund.

Small-cap funds resurfacing for fresh air

Some re-open, others shut, but you stay put

Divergent fund actions

• In recent years, several small-cap funds had shut lump sum investments.
• They are now taking varying actions amid recent shift in market conditions.
• A few have re-opened partially or fully while some remain shut.
• Fund actions are guided by valuation comfort, fund size, and liquidity.
• Bigger funds face capacity constraints, and cannot absorb inflows without performance dilution.
• Smaller funds are guided more by deployment opportunities.

How investors should interpret

• Do not interpret gating of flows as sign to enter or exit.
• The call to shut or re-open may not be driven purely by valuations.
• Funds have varying priorities, investing styles and capacity thresholds.
• Gating should be viewed as a risk-management tool.
• Stay focussed on asset mix, risk tolerance and time horizon.

Cues for investors?

Investors may perceive the closing and reopening of funds for inflows as a sign to exit or enter the small-cap space.

Don’t arrive at such hasty conclusions, caution experts. Valuations alone may not drive the decision to shut or reopen. Asset managers clearly have differing compulsions in gating inflows.

“The divergent behaviour among small-cap funds largely reflects differences in valuation comfort, fund size, and liquidity constraints,” asserts Tandale. The industry split in gating shows that different asset management companies (AMCs) have varying priorities, portfolio construction philosophies, and capacity thresholds, indicates Kumar.

AMCs such as Tata and ICICI Prudential reopening flows suggests that recent market corrections have offered marginal comfort on valuations and deployment opportunities.

In contrast, larger ones like Nippon and SBI continuing restrictions indicates persistent concerns around liquidity risks and the ability to deploy incremental capital without diluting existing investors’ returns, Tandale adds. Valuation comfort itself is highly subjective—fund houses may take differing views, relying on different valuation frameworks. “Two equally competent fund houses can arrive at very different conclusions on whether the segment is expensive,” says Jain.

Gating is primarily a lagging indicator of liquidity and capacity, not necessarily a leading indicator of valuation, suggests Kumar. The reopening by some fund houses suggests the froth of 2024 has largely come off and valuations are more reasonable in many pockets. But the fact that the big boys remain closed is a reminder of the liquidity risk—the exit door is also very narrow, and deployment challenges still exist in the broader small-cap universe, Kumar observes.

Overall, gating should be interpreted as a risk-management tool rather than a buy or sell trigger, suggests Tandale. “Typically, restrictions emerge when excess money chases limited opportunities, often a feature of late-cycle market behaviour. However, reopening does not automatically imply that valuations have turned attractive; it may simply reflect partial correction or improved liquidity conditions.”

Experts advise investors focus on overall portfolio asset mix, own risk tolerance and time horizon instead of timing investment based on funds’ behaviour. In small caps, SIP and systematic transfer plan (STP) should be the preferred modes of investing.