Small Cap Funds for NRIs - Everything You Need to Know

Small cap mutual funds delivered 20-37% returns in the past three years. Some NRIs saw their ₹10 lakh investments grow to ₹25 lakh. Others watched the same amount drop 30% in six months and panicked.

Same fund. Different outcomes. The only difference? Time horizon and timing.

If you're an NRI in Dubai or Abu Dhabi researching small cap funds, you've probably seen the numbers. Nippon India Small Cap Fund: 39.71% five-year returns. 

Axis Small Cap Fund: 30.26% five-year returns. Quant Small Cap Fund: explosive recent performance.

But here's what the marketing materials don't emphasize: These funds also dropped 40-50% during the 2020 crash and took 18 months to recover. They're currently trading at elevated valuations after a multi-year bull run.

And if you're investing rupees while earning dirhams or dollars, you need to factor in currency depreciation on top of market volatility.

At Belong, we've built tools to help NRIs compare investment options beyond just mutual funds. Our WhatsApp community has over 3,000 NRIs who share their experiences daily, and the consensus on small caps is clear: They work brilliantly for patient investors with 7-10 year horizons. 

They destroy wealth for those who panic-sell during corrections.

This guide covers everything-the opportunities, the traps, the tax implications, and when you should skip small caps entirely and choose safer alternatives.

What Exactly Are Small Cap Mutual Funds?

The Securities and Exchange Board of India (SEBI) defines small cap stocks as companies ranked 251 and below by market capitalization. If India has roughly 5,000 listed companies, small caps represent the bottom 4,750 firms.

These are companies with market caps typically below ₹5,000 crore ($600 million). Many are growing businesses you've never heard of: Hawkins Cookers, Sula Vineyards, Kross Ltd, or regional cement manufacturers. 

They're not household names like Reliance or HDFC Bank.

Small cap mutual funds are required by SEBI to invest at least 65% of their assets in these smaller companies. The remaining 35% can go into cash or debt instruments for liquidity.

Unlike large cap funds that invest in India's top 100 blue-chip companies, small cap funds bet on emerging businesses at earlier growth stages. 

The fund manager's job is to identify undervalued companies with strong fundamentals before the broader market discovers them.

Think of it this way: Large caps are established hotels in prime locations. Small caps are food trucks that might become restaurant chains-or go bankrupt trying.

Why Small Caps Outperform (When They Do)

Small companies have advantages that large companies lost decades ago.

Room to grow: A ₹500 crore company can double to ₹1,000 crore by winning a few contracts or expanding to 2-3 new cities. A ₹5 lakh crore company like TCS needs massive revenue growth to double-it's mathematically harder.

Nimbleness: Small firms can pivot quickly. They spot niche opportunities large companies ignore. During the post-COVID boom, many small logistics and healthcare companies captured market share faster than established players.

Underresearched: Only 5-10 analysts cover most small cap stocks versus 50+ covering Infosys or Reliance. This creates mispricing opportunities. When fund managers find hidden gems, early investors benefit disproportionately.

Multiple expansion: As small companies prove themselves, they graduate to mid-cap or large-cap indices. This triggers institutional buying (pension funds, insurance companies), driving valuations higher. You capture gains from both business growth and valuation re-rating.

From 2020-2024, small cap funds delivered exceptional returns because:

• COVID recovery favored domestic-focused businesses
• Government infrastructure spending benefited regional players
• Retail investor participation surged via SIPs
• Corporate earnings grew strongly

According to Trade Brains, the top small cap funds delivered up to 37.5% annualized returns in the past three years as of 2025.

But history also teaches us these cycles reverse. The 2018 IL\&FS crisis saw small caps crash 30% while large caps stayed flat. The 2020 pandemic saw small caps drop 50% versus 35% for Nifty 50.

👉 Tip: Past returns don't predict future performance. Many small caps are currently trading near all-time highs. Starting your SIP at the peak of a bull market requires even longer holding periods to average out.

The Returns Nobody Talks About Honestly

Let us show you real data from current top-performing funds:

Notice the 1-year return for Nippon shows -1.89%. That's a ₹10 lakh investment becoming ₹9.81 lakh in 12 months. Yet the 5-year return is 34.06% because the fund recovered strongly from the 2020 crash.

This volatility is not a bug - it's a feature. Small caps swing wildly. You need to stomach 20-30% drawdowns without panic-selling.

Here's the uncomfortable truth: If you invested ₹10 lakh in January 2025 when valuations were stretched, you might be sitting at ₹9.8-9.9 lakh by October 2025 (depending on the fund). The person who started a SIP in 2019 and held through the crash is up 150-200%.

Returns after taxes for NRIs: If you held for 3 years and made ₹5 lakh profit:

• Gross return: 50%
• Tax: 12.5% on (₹5 lakh - ₹1.25 lakh) = ₹46,875
• Net return after tax: ~45%

Compare this with GIFT City USD fixed deposits offering 4.5-6% annual returns with zero tax and zero volatility. Over 5 years, that's 25% cumulative (tax-free) in a stronger currency.

Small caps must significantly outperform to justify the risk and rupee exposure.

Tax Treatment for NRIs

Small cap funds are classified as equity funds for taxation since they hold 65%+ in equities. This gives NRIs preferential tax rates compared to debt instruments or NRO fixed deposits.

Short-Term Capital Gains (holding period under 12 months): 20% + applicable surcharge + 4% health and education cess

Long-Term Capital Gains (holding period 12+ months): 12.5% on gains exceeding ₹1.25 lakh annually + applicable surcharge + 4% cess

Tax Deducted at Source (TDS): When you redeem your units, TDS is automatically deducted at 20% for NRIs without considering the holding period. You claim the excess back when filing your NRI tax returns.

DTAA Benefits: If you're a UAE resident (where there's no capital gains tax), India's Double Taxation Avoidance Agreement allows you to get taxed only in India at the rates above. You won't be taxed again in UAE on the same gains.

To claim DTAA benefits:

1. Obtain a Tax Residency Certificate (TRC) from UAE
2. Submit Form 10F and TRC to your fund house
3. File your Indian tax return claiming relief under Article 13 (Capital Gains)

Read our detailed guide on claiming DTAA benefits for NRIs.

Example calculation: You invest ₹20 lakh and redeem after 18 months at ₹27 lakh.

• Capital gain: ₹7 lakh
• Exempt: ₹1.25 lakh
• Taxable: ₹5.75 lakh
• LTCG tax at 12.5%: ₹71,875
• Net proceeds: ₹26.28 lakh

Your effective tax rate on the entire gain is 10.3%, not 12.5%, because of the ₹1.25 lakh exemption.

👉 Tip: If you have multiple equity investments, strategically time your redemptions to stay within the ₹1.25 lakh exemption annually. Redeem ₹1.25 lakh gains in March and another batch in April (new financial year) to use the exemption twice.

For detailed taxation rules, check our comprehensive guide on taxation of mutual funds for NRIs.

Also Read - How to Choose the Right Mutual Fund as an NRI

Small Caps vs Large Caps vs Mid Caps: Honest Comparison

The key difference is resilience during downturns. When markets crash, large caps fall 25%, mid caps fall 35%, and small caps fall 45-50%. But the recovery trajectory favors risk-takers who stayed invested.

2020 COVID crash example:

• Large caps recovered to pre-COVID levels: 9 months
• Mid caps: 15 months
• Small caps: 18 months
• But small caps then rallied 120% from the bottom versus 80% for large caps

If you're investing through SIPs, this volatility works in your favor through rupee cost averaging. You buy more units when markets crash. But for lumpsum investors timing the entry wrong, it's painful.

Also Read - Types of Mutual Funds

How Much Should Small Caps Be in Your Portfolio?

Our recommendation at Belong for NRIs: Maximum 15-20% of your India equity allocation.

Here's why:

Sample NRI Portfolio Allocation:

Total India investments: ₹50 lakh

• GIFT City USD FD: ₹15 lakh (30%) – Safety + USD + Tax-free
• Large cap equity funds: ₹15 lakh (30%) – Stability
• Balanced advantage or hybrid funds: ₹10 lakh (20%) – Balanced risk
• Small cap funds: ₹7.5 lakh (15%) – Growth
• NRE FD (emergency fund): ₹2.5 lakh (5%) – Liquidity

Why not more in small caps?

1. Liquidity risk: During crashes, selling small cap funds is harder. NAVs can gap down 5-7% in a single day.

2. Currency risk amplification: You're earning in a strong currency (USD/AED) and investing in a volatile asset (small cap stocks) in a depreciating currency (INR). Double risk.

3. Behavioral risk: When your ₹10 lakh becomes ₹6 lakh, will you hold or panic? Most NRIs panic because they check portfolios more frequently from abroad.

4. Goal misalignment: If you plan to return to India in 5 years and need the money for a house down payment, small caps are too risky for that timeline.

👉 Tip: Use our Compliance Compass tool to check if your overall portfolio allocation across categories meets regulatory requirements and risk guidelines.

The Risks They Don't Advertise

1. Valuation Risk Small cap indices are trading at 20-25x forward earnings as of October 2025, higher than the 15-20x historical average. Mean reversion is inevitable. When it happens, small caps typically correct 30-40%.

2. Liquidity Risk Many small cap stocks trade thin volumes. When fund managers need to sell during redemption pressure, they might not find buyers without impacting prices. This is why some funds impose exit loads.

3. Quality Risk Not all small cap companies have robust governance. Some have weak balance sheets, family management issues, or accounting red flags. Fund managers can make mistakes in stock selection.

4. Sectoral Concentration Some small cap funds are heavily concentrated in 2-3 sectors. If those sectors underperform (like chemicals did in 2023-24), the entire fund suffers.

5. Manager Risk Small cap fund performance depends heavily on the fund manager's stock-picking ability. If the manager leaves, performance often deteriorates. Check fund manager tenure before investing.

6. Expense Ratios Small cap funds have higher expense ratios (0.70-1.50%) versus large cap funds (0.40-0.80%). On a ₹10 lakh investment over 10 years, a 1% higher expense ratio costs you ₹1.5-2 lakh in reduced returns.

7. Exit Load Traps Most funds charge 0.5-1% exit load if you redeem within 1 year. Emergency exits become expensive.

8. Recovery Uncertainty Unlike large caps where Nifty 50 will eventually recover, individual small cap companies can go bankrupt. Kingfisher Airlines, DHFL, and Jet Airways were once in indices.

Check our guide on common NRI investment mistakes to avoid these pitfalls.

How to Invest: The Step-by-Step Process for NRIs

Step 1: Determine Your Residential Status

Your tax treatment depends on whether you're classified as NRI, RNOR, or Resident. Use our free Residential Status Calculator to find out.

Step 2: Open NRE or NRO Account

You need an Indian bank account to invest in mutual funds. Options:

• NRE Account: For repatriable investments using foreign earnings. Fully repatriable principal and returns.
• NRO Account: For non-repatriable or income earned in India. Repatriable up to $1 million per year under LRS.

Read our detailed comparison of NRE vs NRO vs FCNR accounts.

Step 3: Complete KYC

KYC compliance is mandatory. Required documents:

• PAN card (apply online if you don't have one)
• Passport copy with valid visa
• Overseas address proof (utility bill, bank statement)
• Recent photograph
• Signature specimen

Most platforms now offer video KYC for NRIs. Turnaround time: 5-7 business days.

Important for US/Canada NRIs: Due to FATCA compliance, many fund houses restrict NRIs from US and Canada to offline-only transactions. Check with the specific AMC (Asset Management Company) before starting.

Also Read - DTAA Between India and USA

Step 4: Choose Between SIP and Lumpsum

Systematic Investment Plan (SIP):

• Invest fixed amounts monthly (₹500-10,000+)
• Rupee cost averaging during volatility
• Disciplined approach
• Better for most NRIs

Also Read - Best SIP Options for NRIs – Step by Step Guide

Lumpsum:

• Invest entire amount at once
• Suitable if you have surplus cash
• Higher timing risk
• Better when markets are clearly undervalued

For small caps, we strongly recommend SIP over lumpsum. Timing the market is nearly impossible. SIPs ensure you buy across market cycles.

Also Read - Can NRIs Continue SIPs After Moving Abroad?

Step 5: Select the Funds

Look for:

• Consistent 5-year returns (not just recent 1-year)
• Large AUM (₹5,000+ crore shows credibility)
• Low expense ratio (under 1%)
• Experienced fund manager (5+ years tenure)
• Diversified portfolio (50+ stocks, not overly concentrated)

Step 6: Link Your Bank and Start Investing

You can invest through:

• AMC websites directly (SBI MF, Nippon India, etc.)
• Aggregator platforms (INDmoney, Groww, Zerodha Coin)
• Distributor platforms

Direct plans have lower expense ratios than regular plans. Always choose Direct.

For a curated list of best investment platforms for NRIs, check our comprehensive guide.

👉 Tip: Set up auto-debit for SIPs on a date after your UAE salary credit date (typically 1st or 5th of the month). This ensures sufficient balance in your NRE/NRO account.

Repatriation: Can You Bring the Money Back?

Yes, but the rules differ by account type.

Invested via NRE Account:

• Fully repatriable (principal + gains)
• No limit on amount
• No special documentation
• Proceeds credited to NRE account, then transfer to UAE

Invested via NRO Account:

• Repatriable up to $1 million per financial year per person
• Requires CA certificate and Form 15CA/15CB
• Subject to TDS on capital gains
• More documentation

For detailed repatriation rules, read our guide on NRE account repatriation.

Redemption timeline:

1. Place redemption request online/offline
2. Units redeemed at next available NAV
3. TDS deducted automatically
4. Proceeds credited to linked NRE/NRO account in 3-4 business days
5. Transfer to UAE bank account via SWIFT (1-3 days)

Total time: 5-7 business days from redemption to UAE bank credit.

When You Should SKIP Small Caps Entirely

Don't invest in small cap funds if:

1. Your investment horizon is under 5 years

Small caps need time. If you need money for a house purchase in 2027, don't start a small cap SIP in 2025. Choose debt funds or fixed deposits instead.

2. You check your portfolio daily

Small caps will torture you. Daily volatility of 2-3% is normal. If this causes stress, stick to large caps or balanced advantage funds.

3. You're close to retirement

If you're 55+ and planning to retire in India at 60, your risk capacity is limited. Focus on capital preservation through GIFT City FDs or senior citizen FD schemes.

4. You don't have an emergency fund

Never invest in small caps if you don't have 6-12 months' expenses in liquid form. Build your emergency fund first in NRE savings accounts or liquid funds.

5. This is your only India investment

Don't make small caps your first and only India investment. Build a diversified base with large caps, FDs, and safer instruments. Add small caps as a satellite position later.

6. You believe the hype

If you're investing because you saw 40% returns and want quick wealth, you're going to lose money. Greed is the worst investment strategy.

7. Current valuations are elevated

As of October 2025, small cap indices are near all-time highs after a 3-year rally. Starting fresh lumpsums now increases timing risk. Wait for corrections or start small SIPs.

Better alternatives for the above scenarios:

• GIFT City USD fixed deposits: 4.5-5% tax-free returns in dollars
• Large cap index funds: Lower volatility, proven recovery track record
• Balanced advantage funds: Automatic asset allocation between equity and debt

Top Small Cap Funds for NRIs in 2025

Based on historical performance, fund size, and manager track record:

Our approach at Belong: We don't recommend single funds. Instead, diversify across 2-3 small cap funds to reduce manager risk. Invest 50% in a large established fund (Nippon, Axis), 30% in a mid-sized fund, and 20% in a high-growth fund (Quant).

Use our NRI FD comparison tool to see how small cap projections compare with guaranteed returns.

SIP vs Lumpsum: What Works Better?

For small caps specifically, SIPs are almost always superior for three reasons:

1. Volatility averaging: Small caps swing 30-50% in a year. SIPs buy more units when prices are low and fewer when high. Over 7-10 years, this significantly improves returns.

2. Behavioral discipline: SIPs remove emotion. You invest the same amount regardless of whether Sensex is at 60,000 or 80,000.

3. Timing risk mitigation: Nobody can predict market tops and bottoms. If you invest ₹10 lakh lumpsum in January 2025 and markets crash in March, you've locked in losses. With SIP, you'd average down.

Real example from our community:

Rajesh (UAE-based NRI) started a ₹25,000 monthly SIP in Axis Small Cap Fund in January 2019:

• Total invested by December 2024: ₹18 lakh (72 months)
• Current value: ₹34 lakh
• Returns: 89% absolute, ~17% CAGR

His colleague Vikram invested ₹18 lakh lumpsum in January 2020 (just before COVID crash):

• Current value: ₹28 lakh (after recovery)
• Returns: 56% absolute, ~13% CAGR

Same fund. Different strategies. SIP won because it averaged through the crash.

👉 Tip: Start with ₹5,000-10,000 monthly SIP. Increase by 10% annually as your UAE salary grows. This "step-up SIP" accelerates wealth creation.

Join our WhatsApp community where members share their SIP strategies and performance updates.

The Exit Strategy Nobody Teaches

Most articles tell you when to enter small cap funds. Few tell you when to exit. Here's our framework:

When to Exit (Sell Some or All):

1. Goal achievement: You started investing for your child's education. They're now in 11th grade and need the money in 2 years. Start redeeming 50% now, 50% over the next 12 months.

2. Valuation extremes: If Nifty Small Cap 250 index P/E exceeds 30x (vs. 15-20x average), book partial profits. Redeem 30-40% and move to debt funds or FDs.

3. Life stage change: You're 58 and retiring to India in 3 years. Shift from growth to preservation. Start systematic withdrawal plans (SWP).

4. Fund deterioration: Your fund manager left. Performance dropped below category average for 2 consecutive years. Switch to a better-performing fund.

5. Better opportunities: Small caps have rallied 150% in 3 years. Large caps are trading at 18x P/E (attractive). Rebalance by booking small cap profits and buying undervalued large caps.

When NOT to Exit:

• Market volatility (down 10-15% from peak): This is normal. Don't panic.
• Negative news about one stock: Diversified funds have 50+ holdings. One bad stock impacts <2% of portfolio.
• Friend's advice: "I heard small caps will crash." Market timing rarely works.

Tax-efficient exit strategy:

Year 1: Redeem ₹2 lakh (Gain: ₹1.2 lakh) → Tax on ₹0 (under exemption)

Year 2: Redeem ₹2.5 lakh (Gain: ₹1.3 lakh) → Tax on ₹50,000 at 12.5% = ₹6,250

Year 3: Continue similar redemptions

By spacing redemptions, you use the ₹1.25 lakh annual exemption multiple times.

For detailed exit strategies, check our guide on NRI taxation planning.

Small Caps vs GIFT City: An Uncomfortable Comparison

Let's be direct about something most mutual fund advisors won't tell you.

Scenario: You have ₹25 lakh to invest for 7 years

Option A: Small Cap Fund SIP (₹30,000/month for 7 years)

Assuming 18% annual returns (optimistic based on past):

• Total invested: ₹25.2 lakh
• Expected value: ₹46 lakh
• Capital gain: ₹20.8 lakh
• Tax at 12.5%: ₹2.44 lakh (after ₹1.25L exemption)
• Net proceeds: ₹43.56 lakh

But rupee depreciated 3.5% annually:

• Real value in USD terms: ~$45,000 (at ₹97/$)

Option B: GIFT City USD Fixed Deposit

$25,000 at 6% p.a. for 7 years:

• Maturity value: $35,000
• Tax: Zero
• Currency risk: Zero
• Net proceeds: $35,000

Plus, you sleep peacefully. No volatility. No panic during crashes. Fully repatriable. DICGC insured.

The question: Is the potential $10,000 extra from small caps worth the volatility, rupee risk, and 7 years of stress?

For many NRIs, the answer is no. Especially when you account for the likelihood of panic-selling during a 40% drawdown.

This is why at Belong, we built a platform for GIFT City investments. Tax-free USD returns between 4.5-5% with zero volatility often beat small cap returns after adjusting for risk and currency depreciation.

Download the Belong app to compare live rates and calculate which option suits your risk profile.

The Bottom Line: Are Small Caps Right for You?

Small cap funds work brilliantly for NRIs who:

• Have 7-10+ year investment horizons
• Can stomach 30-50% temporary drawdowns without panic
• Already have a diversified portfolio with safer assets
• Understand that past returns don't guarantee future performance
• Are willing to invest via disciplined SIPs, not lumpsums

Small cap funds DON'T work for NRIs who:

• Need money within 5 years
• Are investing for the first time
• Get stressed by volatility
• Are in a rush to "make quick money"
• Haven't completed proper KYC or lack basic understanding of equity risks

The reality is that most NRIs are better served with a hybrid strategy: 60-70% in safe instruments (GIFT City FDs, NRE deposits, large cap funds) and 15-20% in small caps for growth.

At Belong, we help NRIs build such balanced portfolios. Our tools compare all investment options- - FDs, mutual funds, GIFT City deposits- - in one place. Our community of 3,000+ NRIs shares real experiences, not marketing pitches.

Your next steps:

1. Use our Residential Status Calculator to confirm your tax status
2. Compare expected small cap returns with guaranteed GIFT City rates using our calculator
3. Join our WhatsApp community and ask questions to our financial advisors
4. Download the Belong app to start investing in diversified, tax-efficient products

Remember: The goal isn't to pick the highest-returning asset. The goal is to pick the asset that lets you sleep peacefully while building wealth over decades. Sometimes, that's small caps. Often, it's a mix of everything.

Make smarter financial decisions, not just aggressive ones.

Disclaimer: Mutual fund investments are subject to market risks. Read all scheme-related documents carefully. This article is for educational purposes only and does not constitute financial advice. Past performance does not guarantee future returns. Consult a SEBI-registered investment advisor before making investment decisions.

Sources:

• Securities and Exchange Board of India (SEBI) guidelines
• Association of Mutual Funds in India (AMFI) data
• Groww Small Cap Funds List
• GoINRI Small Cap Guide
• INDmoney Fund Performance
• Trade Brains Research
• Income Tax Department of India