How To Invest In Small-Cap Funds

Kirtan Shah: Ideally, if you look at the risk return data points, the answer to this question is very simple.

If you allocate equal proportion to a large, mid, small cap versus a multicap or versus flexicap, you will see that on a risk-return basis, the large, mid and small cap has delivered a much superior performance then investing in a multicap or a flexicap.

For somebody who is very clear that they have five, seven years of investment horizon at least, should definitely do a large, mid, and small cap bifurcation in the fund than choosing a multicap or a flexicap.

That is a better portfolio building strategy than just investing in two-three multicaps or flexicaps and let the fund manager decide what they really want to do.

While you’re trying to look at investing in a small cap, I would definitely not advise anybody who has got anything less than a five-year or seven-year time frame to invest in a small cap irrespective of what the last one year’s performance has been.

In fact, in the current situation, it is more of a problem because you are not sure of whether the valuations are correct to be paid at this point in time. There’s too much of a macro overhang and that can definitely have a stronger impact, probably, if markets have to move southward.

The bigger challenge that I see on the small cap side is actually the AUM of the fund. All of us know that everybody keeps kind of moving on to a fund that has been performing and the AUM keeps increasing.

Let me give an example of the two funds mentioned – Nippon Small Cap and Quantum. Now both these funds started in 2013, so they have a good eight-nine year-old history that you can go back to and see if the funds have done well.

If you look at the returns of the funds, both have done really well. Nippon is today managing close to Rs 19,200 odd crore worth of AUM, as of March 31.

If you look at the 251st stock, which by SEBI definition gets categorised as small cap, the market cap of that stock is almost as good as the AUM that the fund is managing. Now, because of that problem, you will see that so much of AUM does not get deployed in the small cap space.

Nippon has 141 stocks in which they have invested precisely for this reason because they can’t do investing of Rs 19,000 crore in small caps.

The exposure to small cap is only 45% of the total portfolio because you have the leeway to move around in large cap and mid cap. They only have 45% investment in the small cap and this is actually a problem across all small-cap funds, atleast on the performing side of the stocks.

If you look at Quant, it has moved up aggressively. They’ve been able to get there over the last one-and-a-half years because of the performance, but they’re still close to Rs 1,600 odd crore worth of AUM. In terms of AUM, Quant is in a much better position than probably Nippon.

They are only managing 56 stocks because of the kind of money that they have to deploy. They don’t really have to go and gather 150 stocks. If you look at the exposure to small cap in Nippon, it is 56% which probably is the highest in most of these funds that we are discussing today.

Talking about a small cap fund where you want the fund to take exposure to small caps, lower AUM, higher exposure to small caps and a lower turnover ratio probably works well. So, I would not mind looking at Quant Small Cap as well.