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Mutual Funds - Be cautious when buying small-cap funds

SBI Small Cap and DSP Small Cap funds are scheduled to reopen to lump sum subscriptions from 30 March and 1 April, respectively. Nippon India Small Cap Fund is also expected to do so in a few days, said a senior executive from the asset management company, on the condition of anonymity. The small cap category has corrected by 27.55% since the start of 2020, as on 27 March, according to data from Value Research. The correction has pulled down its long-term compounded annual growth rate (CAGR) as well with the five-year CAGR at just 0.12% and 10-year CAGR at 7.35%. However individual schemes have managed to deliver higher returns over the long term, making scheme selection important in this space. So is this a good time to invest in small-cap funds?

SBI Small Cap fund had closed itself to fresh subscriptions in 2015 after hitting its maximum size of 750 crore (at the time, it defined small-caps as those below the top 400 companies by size), as per its scheme information document (SID). After the Securities and Exchange Board of India (Sebi), in October 2017, broadened the definition of small-caps to those below the top 250 companies, the fund in 2018 opened systematic transfer plans (STPs) and systematic investment plans (SIPs) up to 25,000 per month. “We believe there are attractive opportunities post the recent correction and, hence, we are allowing lump sums now. We’ve not seen net outflows from the fund yet," said R. Srinivasan, head of equity at SBI Mutual Fund. The fund will only accept an additional 1,000 crore in lump sums.

“You should invest in mid- and small-caps because of the sheer size of the universe compared to large-caps," said Srinivasan. There are about 4,750 listed companies in the small-cap space compared to 100 in large-cap and 150 in mid-cap spaces.

DSP Small Cap (earlier DSP Microcap) was one of the biggest schemes in the space with assets under management (AUM) of 6,890 crore in December 2017. It gave a 101.8% return in 2014, as per Value Research, effectively doubling the money of investors in that year. As money flooded in, the fund progressively throttled flows. Investments were restricted to 2 lakh per person in 2014 and 1 lakh per person in August 2016. In February 2017, it stopped accepting fresh money.

After a bit of market correction, the fund cautiously opened SIPs and STPs in September 2018. “Calibrating when to invest and when not in the space is important," said Kapen Parekh, president, DSP Investment Managers. “I am pleased that my colleague Vinit (Sambre, head of equities, DSP Mutual Fund) decided to stop taking new flows in 2017—a bit before the peak in 2018. Since 2018, the small-cap index has lost about 50%. The valuations were stretched then and opportunities to invest limited. Now, after the rapid correction in March 2020, we feel the time is right to take advantage of cheaper valuations of high-quality-high-ROE (return on equity) small-cap stocks," said Parekh.

Experts are divided on investing in small-cap funds at this juncture.

“Current valuations in the small-cap space are factoring in a lot of the economic damage from the Covid-19 outbreak. If the disruption extends further, small-cap stocks will not fall as much as large-caps. However, investors should not put money in one go, and spread out their investments," said Deepak Jasani, head of retail research, HDFC Securities.

But other experts differ. “Valuations in this space could still be stretched. The Covid-driven economic disruption will have many hard-to-predict effects and investing now is an act of faith. If you really want to invest, do SIPs or STPs over the next four years. Do not invest lump sums," said Shyam Sekhar, chief ideator, iThought Advisory.

Belapurkar also warned investors to be careful about a fund’s size in this category. “Investors should consider a fund’s size and ability to manage flows while picking a scheme. Funds receiving significant flows may have to hold higher cash levels to ensure effective deployment into small- caps given constrained liquidity on these counters," he added. As of 29 February, SBI Small Cap had an AUM of 3,476 crore, DSP Small Cap 5,045 crore and Nippon India Small Cap has an AUM of 8,567 crore.

Even though AMCs are opening up small-cap funds to lump sums, you need to be cautious. Opt for SIPs or STPs or staggered lump sums only. Also, your holding period in small-caps must be greater—seven years or longer—than other equity segments. Investing in multi-cap funds may be a less risky approach as they invest a portion in small-cap stocks. The extent of exposure in small-cap funds depends on your risk appetite and financial goals. If you cannot figure this out by yourself, speak to a financial adviser.

Source : Live Mint back