In September, small-cap funds attracted Rs 2,678 crore in investments, overshadowing mid-cap funds’ Rs 2,234 crore. A similar trend was observed in August. However, large-cap funds witnessed outflows of Rs 110 crore.
Even as large fund houses have begun restricting lump sum inflows into small-cap funds, Quantum Asset Management Company is bullish on the opportunity in the small-cap space. It expects such funds to deliver better returns as the Indian economy grows.
Quantum Small Cap Fund, an open-ended scheme that aims to generate capital appreciation by investing in small-cap stocks, opens for subscription today. The fund is benchmarked against S&P BSE 250 Small Cap Total Return Index (TRI) and co-managed by Chirag Mehta, Chief Investment Officer and Fund Manager, Quantum MF and Abhilasha Satale, Assistant Fund Manager.
The small-cap fund is meant for investors looking for long-term capital appreciation. “We have seen that in the long term, small-cap stocks have demonstrated the capability of giving good returns potential,” said Mehta.
But why launch another small-cap fund when valuations seem too high?
“On an aggregate basis, valuations might look a tad expensive but if you carefully analyse the large universe of 900+ stocks with meaningful liquidity and market caps, we do find opportunities which are growing fast and appear reasonably priced. Also, we do see an opportunity for a fund in the small-cap space that is mindful of capacity that emanates from liquidity and market cap constraints, one that does not have long tails with sub-optimal weights in the portfolio and one that’s true to label. There is relatively higher risk in the small-cap investing and we don’t want to enhance risks like that of liquidity or over-diversification in the fund,” Mehta told Business Standard.
Small Cap Funds have the potential to create significant wealth and alpha over the long term, albeit at higher risk compared to other equity mutual fund categories.
The Scheme Investment Philosophy include:
Disciplined about fund capacity to prevent large sizes becoming a hindrance to performance.
Prioritizes Liquidity – Minimum Rs 2 CR Average Value per day in all stocks
High-Conviction Portfolio – Of 25 to 60 Stocks for optimal diversification to avoid becoming a “Closet” Small Cap Index.
Agile Portfolio Construction – Track Record since 2006 of judiciously building portfolios.
Ensuring Limited Ownership – General limit of 5% of market capitalisation holding in all stocks.
Sizeable Stock Exposure – Minimum weight of 2% at cost in each stock
Mehta believes the biggest challenge in the small-cap mutual fund space today is a large asset under management (AUM) size. “Funds with large AUM tend to face liquidity issues if they end up owning a big part of a small-cap stock’s market capitalization. They may be compelled to have a long tail of stocks with unsubstantial weights. They may be forced to either sit on cash or to invest incremental inflows into mid or large-cap names, which is not what a small-cap fund’s objective is. The Quantum Small Cap Fund will limit its AUM size to an optimal level, which will enable it to hold a high-conviction, liquid portfolio of promising small cap businesses,” he said.
Currently, the average time for a small-cap fund to liquidate the asset ranges from 200 days to 1,623 days depending on the fund size.
“Many of the new startups that have sprung up to solve many problems faced by the population could eventually list as small-cap companies and then eventually grow into sizable companies in the mid-cap or large-cap space,” said I. V. Subramaniam, MD & Group Head- Equities, Quantum Advisors – Sponsor to Quantum Mutual Fund.
Subramniam believes the growth of the economy will be led not only by the large companies but by many startups that have sprung up in the last few years. The smallcap space currently includes more than 85 percent of the listed companies.
For the NFO, liquidity will be prioritized and a high conviction portfolio where 25-60 stocks will be chosen for optimal diversification.
What should you do as an investor?
However, Value Research’s Hritik Madan notes that over the last 23 years, just 13 per cent of small-cap stocks graduated to mid-caps or large-caps, while 29 per cent tumbled into the micro-cap territory. Therefore, when considering small-cap investments, it’s imperative to grasp these risks.
” Allocate small-cap funds judiciously in your portfolio. They can be a valuable addition but also come with higher risk and volatility. Over the long term, they can boost your overall returns. Generally, it’s recommended to allocate 50-70 per cent to your core portfolio in large-cap funds, 20-30 per cent in mid-cap funds, and 10-20 per cent in small-cap funds. To maximise returns, make portfolio rebalancing your ally. When small-cap stocks surge, sell some (since their value in your portfolio will increase) and adjust back to the recommended allocation. When they decline, buy them at discounted prices,” said Madan.