Small cap funds invest in companies ranked 251+ by market capitalization, offering the highest growth potential but with significantly higher risk and volatility. They have the highest volatility among all fund categories, maximum growth potential, and lower liquidity compared to large and mid cap stocks.

Manage risk by diversifying across multiple small cap funds, limiting allocation to 10-15% of equity portfolio, using systematic investment approach for rupee cost averaging, maintaining long-term investment horizon, and monitoring fund performance regularly. Consider your risk tolerance and investment goals.

For aggressive investors, allocate 10-15% of equity portfolio to small cap funds. For balanced investors, 5-10% allocation is appropriate. For conservative investors, 3-5% allocation is sufficient. Diversify across 2-3 quality small cap funds to reduce concentration risk. Consider your risk tolerance and investment horizon.

Choose small cap funds based on consistent performance track record, strong risk management and volatility control, experienced fund management team, reasonable expense ratios, and optimal AUM size. Consider funds with good long-term performance, strong risk-adjusted returns, and consistent performance across different market cycles.

Key risks include highest volatility among all fund categories, significant drawdown risk (40-60% during market stress), lower liquidity compared to large and mid cap stocks, higher company-specific risks and concentration, and economic sensitivity and growth dependence. Diversification and risk management are crucial for successful small cap fund investing.