ITI Mutual Fund has launched ITI Small Cap Fund. The fund opens for subscription on January 27 and closes on February 10. In this interview, George Heber Joseph talks about this fund and shares his views on equity markets.
What is the rationale for launching a small-cap fund?
Small cap investing can be really rewarding if you can time it well. Asset allocation, small cap investing, identifying sectors & stocks to invest timing is essential. The returns from small cap segment during economic upturn are very high but the volatility is also high. Hence, the valuations and the time when an investor invests in this segment, is very important. We believe today the small cap segment of the market is very attractively priced in and risk reward is quite favorable. Our strong belief is that Indian economy is close to the bottom of the economic cycle. During the downturn of the last two years, small cap equities have seen both earnings estimate downgrades and P/E de-rating, resulting in significant underperformance. Today, most investors are not very enthusiastic about investing in small caps. Thus the small caps can potentially give very good returns as economic growth improves and P/E multiples re-rating happens. Also the small cap universe is quite broad and spread across several sectors thereby giving ample opportunities for stock picking.
What would be the fund management strategy to manage this fund?
Similar to our other equity funds, we will adopt our fund house ‘SQL investment philosophy' in managing the small cap fund. Here 'S' stands for Margin of Safety, 'Q' for Quality of the Business and 'L' for Low Leverage. At least 80% of the portfolio will be of core stocks with decent industry position and 13% average RoE over the long term while tactical bets will not exceed 20% of the portfolio. The fund will be benchmark and sector agnostic. Some of the themes, which would use for stock selection, are
• Stocks from industries undergoing cyclical slowdown
• Stocks from industries facing maximum macro headwinds,
• Stocks from the new emerging sectors / sub sectors
• Stocks from sectors where government policies are encouraging
• Stocks where opportunity size is large and underpenetrated nature of sectors
How this fund would be different from other schemes in the markets?
The fund will invest only in stocks, which at the time of purchase in the fund are classified as ‘small cap stocks’ as per the AMFI classification. Under normal circumstances, we are at least, 90% invested and all such investments will be in small cap stocks. We endeavor to have diversified portfolio with weight of a single stock limited to 3% of the fund. When we feel valuations of small cap stocks are frothy, we will book profits and increase the share of cash / short-term debt in the fund. Thus, the investors in our fund will get full flavor of small cap returns without any dilution due to presence of large cap stocks. We will focus on diversification with larger number of stocks, 60-80 stocks, which will provide more stability to the fund.
Small cap funds have not performed well for quite some time now. What is your take on this?
Typically small caps suffer the most during economic downturns, thus they have borne the brunt of economic slowdown of last two years. Hence, we feel the opportunity is quite attractive now as economy is close to cyclical bottom.
What kind of returns should an investor expects from small cap funds three years from now?
We feel among the three sub segments of equity markets viz. large cap, mid cap and small cap, the most attractive risk reward is available in the small cap segments. Historically, we have observed that whenever valuation differentials between large and small cap stocks reach such high levels as seen currently, small cap stocks provide significant alpha over large and mid-cap stocks.
Why should distributors consider selling small cap funds at this juncture?
As stated earlier, the risk reward profile of small cap equities is very attractive currently. Historically we have seen small cap stocks generating significantly high returns when valuation differentials between large and small cap stocks are high. Thus adding small cap exposure to an investor’s portfolio will significantly enhance the investors overall returns.
Considering the fact that the country’s economic progress is not in a good shape, how do you think the market will play out over the next three years?
We feel Indian economy is closer to the bottom of economic cycle. Several industries have undergone significant growth slowdown or even de growth in the last two years. We believe with improving liquidity and government’s reform measures, growth should start improving gradually. Typically, when growth slows down and credit / liquidity conditions tighten, small cap companies bear the brunt of the slowdown. However when economy improves, these very stocks rebound very smartly. We therefore believe that over the next three to five years, the small cap segment should be the best performing segment.
What should be the ideal time horizon of investors to invest in small-cap funds?
Investor should look at a time horizon of three to five years while investing in small cap funds.
