The Rs 23,000 crore small-cap equity-fund space has been rife with speculation ever since DSP BlackRock Micro Cap Fund applied brakes on fresh inflows. When the most popular small-cap fund makes such a public call, investors are bound to be worried. We spoke with some of the biggest investment managers in the mutual fund industry to get their views on the small-cap-fund space.
Fund size
Comparable with the Rs 4,700 crore size of DSP BlackRock Micro Cap Fund is the over Rs 4,500 crore Franklin India Smaller Companies Fund. Asked about the size of the fund, R Janakiraman, Vice President and Portfolio Manager, Equity, Franklin Templeton Investments India, says that the scalability of this product depends on both the availability of new ideas and the opportunity to increase exposure to existing ideas. "The former has been helped by expanding our coverage universe through higher bandwidth of internal research capability as well as additional ideas made available by IPOs. The recent correction in the market has also helped to increase investments in some existing ideas. There appear to be a few promising IPOs in the pipeline that should further enhance the investable universe," says Janakiraman.
Sunil Singhania, CIO - Equity, Reliance Nippon Life AMC, accepts that he has always been aware of the constraints in the small-cap space. "That is the reason we have taken lump-sum subscription only twice in the history of this [Reliance Small Cap] fund. We feel our current size is manageable. In fact we are quite okay if fresh money comes in a restricted/systematic fashion over a period of time in this fund," he disclosed. "But large lump-sum inflows would be difficult to manage and deploy in the current market environment without too much price impact," he cautions.
New positions
We also asked fund managers if it is challenging to build positions in this market. They indicate that patience is the key. "Investing in small cap necessitates taking a long-term view on businesses. Hence, this also provides longer time frame over which positions can be built," says S Krishnakumar, CIO, Equity, Sundaram Mutual Fund.
Valuations and opportunities
Singhania is of the view that current valuations are high. "If investors are looking at past returns and investing money expecting similar returns, that is not correct. Future returns would be moderate compared to the returns of the last few years. If investors are putting in fresh money now in this space, they should have longer time horizon and return expectation," Singhania says. However, Singhania admits that incrementally it's much more "challenging" to find out alpha ideas.
Pankaj Tibrewal, Senior VP and Equity Fund Manager, Kotak Mutual Fund, thinks that looking at mid- and small-cap stocks as a whole will be incorrect. "At a structural level, most mid-cap and small companies derive a large part of their revenues from India and have relatively lower global exposure. As a result, they are more inclined towards the India growth story and less impacted by the global macroeconomic slowdown. Also, many of these are well placed to benefit from the shift towards the organised sector on the back of demonetisation and GST. Overall, there are a good number of stocks in our investable universe.
Illiquidity a concern?
Illiquidity is always an area of concern for small-cap funds. Janakiraman hits the nail on the head when he says that illiquidity is an occupational hazard for a small-cap investor that is present in most phases of the market. "This is key reason why small-cap investors should have a reasonably long investment horizon. It is this longer horizon that helps the investor overcome the higher impact cost," he says.
Tibrewal says that to balance liquidity, he owns 16 per cent in large-cap stocks.
This column appeared in the April 2017 Issue of Mutual Fund Insight.
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