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Small cap funds have done exceptionally well over the three years. Will this rally continue or it is time to reduce exposure to small cap funds?
To get answers of these pertinent questions, team Cafemutual hosted Chirag Mehta, CIO & Fund Manager, Quantum MF who talked about opportunities and risk in small cap space.
While there were several questions that Chirag addressed, here are the three key common doubts that were put to rest.
Is small cap in a bubble currently?
Many feel that the time for small cap investing is gone. Currently, what you see is a catch-up rally to bring small caps to their long term average. Hence, there is no froth as such and the small caps are rallying because there is earnings growth and the economy is progressing.
If you consider the last 15-year period, the current valuation is below the long term average and if you eliminate the froth during the period 2016-18, then the valuation is only slightly more than the long term average.
While valuation is higher at the index level but given the strong economy, you can look at a small sized fund having a portfolio of select stocks that can help you tap the existing pockets of opportunities.
Also, another important point to note here is that small caps are driven by domestic activities and don’t have much FII allocation. Hence, you should not be worried about FII exits.
Is this the time for small cap investing?
The top 100 companies in terms of market capitalisation are large cap, the next 150 are mid cap and the others are small cap companies. There are over 900 small cap companies with a market cap of over Rs 1,000 crore and this hints at the vast universe of opportunities that small cap investing offers.
To tap such opportunities, consider small cap funds which having a solid portfolio construction. Let me elaborate this:
- The portfolio should have stocks in a meaningful weightage. When a sizeable number of stocks have less than one percentage weightage, the portfolio becomes sub-optimal. In my view, there should be fewer than 10 such stocks to benefit from small cap investing
- Funds with a large AUM face liquidity issues hence you should be mindful of the fund size before investing
- Good governance distinguishes promising small cap companies from others. The stocks in the portfolio should be of companies having strong and sound governance policies
Can you ride on this growth?
Many small cap sectors/themes look attractive. Small finance banks in financial inclusion, original equipment manufacturers (electric vehicles) in auto ancillaries, active pharmaceutical ingredients in health care, etc. are a few examples.
While the possibility of a correction in the small cap can’t be ruled out, a portfolio of attractive small cap stocks can act as a cushion. Investors can look at a 10-15% exposure in the small cap segment across one to three funds.
They can consider Quantum Small Cap Fund which focuses on adequate diversification and creating a portfolio of stocks having quality governance. Moreover, it has strong internal checks to identify promising sectors while keeping track of the fund size to maintain liquidity. Additionally, with its long term approach, the Quantum Small Cap Fund strives to capitalise on compounding what small businesses offer.
You can watch the complete video by clicking here.
Disclaimer: This is an educative initiative of Cafemutual to make distributors aware of the new fund launch. Distributors should conduct their due diligence before making any decisions.
