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.