Principal Mutual Fund is entering the market with equity NFO Principal Small Cap Fund after a gap of eight years.We spoke with PVK Mohan, Head-Equity and the scheme’s fund manager to understand why small cap fund makes sense in current markets.
What is the rationale for launching a small cap fund at a time when small cap stocks are under stress?
CY 2018 saw stark underperformance by small caps, as the small cap index was down 28% but the Nifty was up However market rally was concentrated among a few Nifty stocks. We expect markets to see a more broad-based rally in 2019. Mid cap and small cap companies with strong fundamentals are likely to perform well and, in a sense, may make up for the stark underperformance witnessed last year . Historically too, whenever small caps have corrected sharply they have also bounced back sharply in subsequent years.
What opportunities do you see in the small cap space?
SEBI has defined small cap 251st company onwards in terms of full market capitalization. Analysis of these stocks shows that while these companies may be small in terms of market capitalization, they are quite large in terms of size and scale of operations. Moreover, many of these companies are leaders in their sectors. Even if we look at just the 251st to 500th company by market capitalization, there are a fair number of investment opportunities in the space. Some sectors like chemicals, soft commodities, EPC construction companies, hotels and textiles are better played through the small cap. In addition, some big regional players in organized space are also available in the small cap segment.
What strategy would you follow to create the portfolio and at the same time mitigate risks?
The bedrock of our investment strategy is identifying companies which are growing faster than market expectations, run by good management and in good businesses. We believe that over the long term such stocks have the potential to deliver healthy returns. We follow a bottom up stock-picking strategy for portfolio construction and GARP (Growth at Reasonable Price) philosophy for evaluating investment opportunities. In addition, we also have a proprietary GRP tool, which ranks stocks on 14 fundamental and technical parameters. This gives the research team a good starting point. When it comes to small caps we believe in investing in companies, which have a good risk-reward profile and consistently monitoring them.
There are four main risks faced by small cap funds:
Selection risk – Are you investing in the right companies? We try to mitigate this by quantifying the company’s potential into earnings forecast and evaluating whether the company is available at attractive valuations.
Execution risk – To minimize this risk we avoid one-man shows and look for niche dominant players with good management and a consistent track record.
Portfolio risk: We plan to diversify the portfolio and generally limit per stock exposure to 5% despite higher regulatory allowance.
Liquidity risk: Invest in companies which pass through our liquidity screen.
Overall, we are not in the game to deliver maximum performance rather we want to deliver healthy performance with calibrated risks.
Many advisors and investors are not happy with the recent performance of such funds, how do you plan to revive their confidence?
I have travelled in over 11 cities along with the sales team to address advisor and investor concerns. The regional sales teams are also running road shows in their cities to connect with the advisors and investors. In addition, we have uploaded a few interviews on YouTube, which answer the typical queries.
Which sectors are you bullish on and why?
We are bullish on chemicals, ceramics and sanitaryware, hotels, logistics, construction, sugar and tea and packaging.
- Chemicals: Tighter pollution norms in China are expected to provide opportunities to Indian chemical companies
- Ceramics and sanitaryware: Expected revival due to shift in organized sector post new regulations like GST and pollution control
- Hotels: Increased capacity utilization may support earnings growth
- Packaging: Companies have a close and long work relationships with their customers
- Logistics: Implementation of GST and growth in e-commerce are expected to help these companies
- Construction: Strong order book for next seven quarters plus infrastructure spend by government are likely to help the sector
- Sugar and tea: Favourable government policies with respect to ethanol are expected to curb earning volatility in the sector
How will facilities like STEP and auto trigger help investors? Will these facilities be available throughout the life of the fund?
The STEP facility is a way to stagger the investments over four equal instalments to benefit from the averaging effect in case there is fall in the market. It has a special feature that if the scheme index goes down by 3% during the month, the instalment will be triggered without waiting for the month end. This facility is available only during the NFO period.
Auto trigger is a facility wherein the investor can choose to set a target return and as and when the target return is achieved, the appreciated value can move out to the scheme chosen by the investor. This facility will be available throughout the life of the scheme.
Click on the links below for more updates on Principal Small Cap Fund:
