DSP's Vinit Sambre on picking small caps

After its terrific performance until 2016, DSP Small Cap Fund had two bad years - 2017, when it underperformed both peers and benchmark in a rising market, and 2018, when it did the same thing in a falling market. What went wrong? If you go back to our thought process in 2017, small-cap stocks were heading steadily higher and we were getting worried about valuations. We decided that as we were investing someone's hard-earned money, it was better to stop inflows into the fund so that we didn't end up buying stocks at unreasonable prices. We held a high proportion of cash in our portfolio in the beginning of 2017. The cash call wasn't a deliberate strategy but came from our view that we didn't want to buy at hyper valuations. However, small-cap stocks kept rising that year. Good companies did well but there were several inferior businesses that did even better, the typical third phase of a raging bull market. Due to the higher cash position, we underperformed. Even as we gradually deployed the cash, the kind of small caps we owned - in specialty chemicals, textiles, building materials, pharma - didn't perform in that phase of the market. On the other hand, graphite companies that we didn't own in the portfolio did extremely well. This created a discrepancy between our performance and the benchmark. In the first half of 2018, there were clear signs that the market was topping out, but our specialty chemical, textile and other picks continued to underperform. It is from the end of 2018 that the downfall in small caps began to work in our favour and our stock picks began to turn around on the back of good quarterly numbers. In the last