Subscribers' Hangout: October edition

Shruti Agarwal: Hello and welcome to Subscribers' Hangout. We are back with another episode to answer your queries. So let's get started. So, the first question we have is on small-cap funds: Small-cap funds have appreciated and earned substantial profits. Please advise if we should book profits and shift to large caps or sit on cash for the time being. I'm feeling uneasy seeing these profits. Please note all this money is to be passed on to children. This is for a very long term. Ashutosh Gupta: Sure. So, let me first provide a highly effective and highly implementable answer before talking about some of the issues in a more nuanced way. Now, since you said that this money is for the long term and you otherwise don't have any concerns about the quality of these funds, I don't think it is a good idea to exit and move this money into cash. Because if the markets keep going up from here, it will be a big opportunity loss and present even bigger anxiety and a bigger dilemma as to when to reinvest. Even the fund managers don't take cash calls simply because they don't know when to exit. So, your best source of guidance in such a case should be your asset allocation. We've been saying that you should look at mid and small-cap funds for about 20-25 per cent of your allocation out of your equity portfolio. And you can be guided by that. Beyond this allocation, your flexi cap or other broader mandate funds will also contribute a little bit to this allocation. And broadly, that should be good enough in an overall equity portfolio. Now, once this 20-25 per cent allocation rises and deviates substantially, say it goes up to 35 per cent, then you can act and prune it down to restore it to, say, 25 per cent level. Otherwise, you can continue with this. And I think this kind of approach is pretty evergreen because it works across all kinds of market situations. So, your barometer should not be a market index but your own asset allocation. Having said that, if you want to be much more nuanced about your small-cap allocation, the first thing is to have a precise understanding of exactly how much you own. And that is where the My Investments tool comes in pretty handy. So, if you go to the Analysis tab of My Investments and drill down into the asset allocation, you will get very precise understanding of how your money is divided across stocks of these different market cap segments. And that includes not just your mutual fund allocation but your direct stock investments, if you have any, NPS, and all other such market-linked investments. So, you are guided by precise numbers and not your impressions. That's one. The second thing to remember is that the worst-case scenarios in small-cap funds can be very scary. If you look at the worst one-year returns provided by any small-cap fund in any one-year period in the last 20 years, it comes down to about negative 67 per cent. Now, let me put this number in perspective for you. So, imagine you've been doing a Rs 10,000 SIP in a small-cap fund for the last 10 years. And this fund yields about 18-20 per cent annualised, which is a fair kind of return which these funds have actually yielded in the last 10 years. So this Rs 12 lakh total investment that you make in this fund over this period would grow to around Rs 30 lakh. And one big bear market strikes, and this money just completely wipes off. All that remains is about Rs 10-11 lakh out of this Rs 30 lakh accumulation. And this is not a number that I'm making up out of thin air. This is very much in the realm of reality based on how the experiences have been in the past. And actually, it is this kind of volatility why we suggest that you should look to have just about 20-25 per cent of your money in these kinds of funds. But if this kind of volatility, if this kind of drawdown does not bother you too much, then it is fine. Otherwise, you should look to prune it. More broadly, worst-case scenarios apart, the idea is that even the best of small-cap funds have gone through such phases. And, in all probability, will go through such phases in future where you would wonder why on earth you invested in this fund in the first place. And despite that, over a longer timeframe, they would have turned out to be thoro

This article was originally published on October 14, 2023.