Small Cap Mutual Funds Review, Performance, Who Should Invest

Small Cap Mutual Funds Review - Should you Invest?

Small-Cap Mutual Funds can be one of the most rewarding mutual fund investments. These funds invest at least 65% of their assets in the stocks of smaller companies that are ranked below the top 250 companies in terms of market capitalization on exchanges as per SEBI Categorization. These small companies are relatively young & seek to expand over a period of time. There are possibilities of these smaller companies becoming large companies over the long term because of their potential to deploy high growth strategies, disruptive innovations & reaching out for large market shares through their qualitative products or services. At the same time, there is also a risk of due to the high possibility of such a company being shut down which could bring its value to even zero.

Investments in small-cap funds involve high risk as the underlying companies have low market shares, possible corporate governance issues & unorganized management because of their small sizes. The risk involved in the investments in small caps is very high as compared to the large caps & mid-cap funds. Therefore, investments in small-cap funds are suitable for investors who have a high-risk appetite along with a long investment horizon of at least 7-10 years. Over a long horizon, they present the possibility of providing extraordinary or superior returns when compared to other equity categories. Over shorter periods, they could be highly volatile which might lead to negative returns on investments.

Impact of Covid-19

The Small-cap Index saw a decline of 57% as on 24 March 2020 from it’s all-time high in January 2018. Even the midcap & Sensex were down almost 48% & 39.3% from their all-time highs. Although the markets have recovered quite a bit as the BSE Smallcap index has recovered at least 45% from it's low on 24 March as of 24 June 2020, there's still a lot left to be recovered.

Fall in the small-cap valuations were higher than the large & midcaps because of the small sizes of the companies under small-caps. The small companies generally suffer more than the other companies in the events of crisis owing to the lack of resources, low market shares & insufficient cash flows. In addition to this, when investors sell because of fear it is generally the smaller and riskier companies that are the first casualties. The Covid-19 pandemic has impacted businesses all over the world including our Indian Economy because of the state-imposed lockdowns which resulted in a halt in the business operations of companies irrespective of their size. Hence, it became really difficult for these small companies to survive in the markets as against the big companies which had enough reserves to face this pandemic. As per experts, it is expected that many small companies would not be able to survive in this pandemic leading to permanent closure in their business operations. However, the companies who can manage their resources or come out with innovative offerings at the time of this pandemic would not only be able to surpass this pandemic, but also have the potential to generate extraordinary returns over the next 5 or 10 years.

The NAVs of small-cap funds are expected to recover as the world economy overcomes this pandemic through either the required vaccines or if we have a cure. The choices of the fund manager would matter a lot because some small companies would be out of the market owing to circumstances induced by pandemic. Over the long term, the small-cap funds with quality holdings would be able to generate wealth for its investors.

Must Read: Best Small Cap Mutual Funds to Invest in India

MSME Package 

In May 2020, the central government announced a relief package of Rs.3 lakh crores for MSMEs(Micro, Small & Medium Enterprises). The relief package aimed at passing low-cost credit to the extent of Rs.3 lakh crores to the MSME units to help them sustain their businesses which would have been impacted by the lockdowns amid the pandemic. Later, the central government clarified that the announced package is applicable to all the companies along with the MSME units. The emergency guaranteed credit line offered by the government could be availed by companies through banks at low rates.

However, as per market surveys, most companies have not been able to directly benefit from this package, as banks have imposed their own specific guidelines for which the companies have been facing challenges in accessing the credit facilities. MSMEs being one of the largest employers in the country, a more structured & well-designed package would be required to pass on the benefits directly to the individuals & companies in these units.

Previous Market Crashes- SmallCap Mutual Funds Performance 

Small-cap funds usually fall greater than the midcap & large-cap funds during a market crash. As observed from the past, the large-cap funds are the first ones to lead the market recoveries after the crash is over and later are followed by Midcap & SmallCap funds. Also, it has been observed from the previous crashes that the smallcap benchmark is able to recover a large part (or fully recover) of its fall within 1-2 years after reaching the bottom of the crash.

Given that the Covid-19 situation is very different from the previous crashes, it would be difficult to accurately give any predictive numbers for the road to recovery of the small-caps, because businesses have seen the worst impact in their operations, compared to the past crises. However, it is expected that over the long term smallcap funds would be able to generate above-average wealth for investors.

Below we have listed down the S&P BSE Smallcap Index’s falls & performances in the event of previous market crashes.

 Market CrashesS&P BSE Smallcap Fall%(from high to bottom)Recovery after 1 year from BottomRecovery after 2 years from Bottom
1.Unexpected NDA Defeat (2004)33%248.55%449.21%
2. 
 
Inflation Threat & Higher Interest Rates (2006)42.36%162.59%170.33%
3. 
 
US Financial Crisis (2008-09)79.48%297.58%279.41%
4. 
 
European Debt Crisis (2010-11)44.48%136.03%115.12%
5.
 
Banking Concerns about NPAs (2015-16)22.94%146.73%194.05%

Who should invest in SmallCap Mutual Funds?

Investments in Small-cap funds are suitable for investors having a high-risk appetite along with a long investment horizon. Only investors who can tolerate & settle for the high volatility of the returns over the short periods for the potential gain opportunities over the long term are advised to invest in small-cap mutual funds. The opportunities of earning superior returns from the smallcap funds make these funds as one of the best choices of mutual funds to be put in the MF portfolio for achieving long term financial goals.

Investments in small-cap mutual funds should not comprise a large portion of the portfolio. An allocation between 15-25% of the portfolio, depending on the risk appetite and return objectives could be made in this category. Also, investors are advised to have an investment horizon of at least 7 years while investing in smallcap funds to earn potentially good returns.

Best SmallCap Mutual Funds

1. Nippon India Small Cap Fund

Nippon India small cap Fund is one of the top rated funds in the Equity SmallCap Funds Category. The fund managed by Mr. Samir Rachh since January 2017, has been able to beat the returns of its benchmark & category average returns over the long periods.

The fund has given outstanding returns of around 13.52% since its inception in September 2010. 

Worth of Investments

  • A Lump Sum Investment of Rs.1 Lacs for 7 Years would have grown to Rs.3.81 Lacs.
  • SIP Investments of Rs.10,000 every month for 7 Years would have grown to Rs.11.73 Lacs.
 5 Year Returns7 Year ReturnsAUM(Cr.)
Nippon India Small-Cap Fund7.75%21.08%6,944
Category Average3.66%14.67% 
S&P BSE 250 SmallCap TRI0.88%9.17% 

Returns as of 24 June 2020

Analysis

  • Portfolio: The fund has a diversified portfolio of a total of 114 stocks(highest in the category) with major exposures of 18.45% & 13.76% to the Chemicals & FMCG sectors. However, the large portfolio of stocks may not be a major problem because of the fund’s AUM of Rs.6,944 Crores which is the highest in the Small Cap space. For the Equity Investments, the fund has been invested predominantly in Small Cap stocks with a portfolio exposure of approximately 73% & the rest of its assets are invested in Large & Mid Caps ensuring liquidity needs. The Fund’s Top 3 major shareholdings include exposures in Deepak Nitrite, Navin Fluorine International & Tata Consumer Products. Along with the equity investments, the fund has approximately 2.2% of its portfolio as Cash & Cash Equivalents.
  • Consistency: The fund manager has been able to generate alpha for the 5 years out of the last 5 years calculated for the annual returns. Alpha is the excess returns generated by the fund over the benchmark returns.
  • Volatility:  The fund has a lower standard deviation(26.59) as compared to its benchmark i.e S&P BSE 250 Smallcap (28.19). But it is slightly higher than its category average(25.38). The standard deviation of a fund essentially denotes the volatility of the fund. A lower standard deviation than the benchmark would mean the fund is expected to be less volatile than its benchmark, And a higher SD than the category average is expected to result in a high volatility by the fund as compared to its category. However, with higher volatility, there are possibilities of higher returns than the category average returns & the same otherwise.

Another risk measure Beta which denotes the sensitivity of the scheme’s returns against the market ups and downs is 0.93 calculated for the last 3 years which is more than the Small-cap category average beta of 0.87. This means that the fund is expected to exhibit higher volatility than its category average. 

  • Valuations: On the valuations front, the important valuation metrics like P/B ratio(1.57) is higher than the benchmark’s P/B of 1.18, P/E multiple(11.65) which indicates the investment strategy followed by the fund is currently lower than the fund’s benchmark i.e S&P BSE 250 Smallcap Index P/E multiple of 24.70. Lower P/E multiple metric than the benchmark states that the fund’s underlying stocks have been undervalued as compared to the benchmark’s valuations for which the fund would have the potential to generate good returns over the long periods.
  • Note: One important fact that needs to be considered by investors is the “ Large AUM” of this fund. As it could create liquidity issues for the fund in the turbulent times where the fund manager might not be able to liquidate its positions to meet redemptions because of its large holdings in the stocks.

However, the fund’s portfolio consisting of holdings in large caps, mid-caps, and cash & cash equivalents will ensure liquidity in the fund’s portfolio. So, investors must proceed with caution while investing in this fund and regularly look into the portfolio exposures.

2. SBI Small Cap Fund

SBI Small Cap fund is one of the top-performing funds in the equity smallcap funds category. The fund managed by Mr. R. Srinivasan since November 2013 has been able to beat the returns of its benchmark & category average returns by significant margins.

The fund has delivered excellent returns of around 15.85% since its inception in September 2009.

Worth of Investments 

  • A Lump Sum Investment of Rs.1 Lacs for 7 Years would have grown to Rs.4.17 Lacs.
  • SIP Investments of Rs.10,000 every month for 7 Years would have grown to Rs.13.46 Lacs.
 7 Year Returns10 Year ReturnsAUM(Cr.)
SBI Small Cap Fund22.62%16.38%3,374
Category Average14.67%8.97% 
S&P BSE 250 SmallCap TRI9.17%2.45% 

Returns as of 24 June 2020 

Analysis

  • Portfolio: The fund has a well-diversified portfolio of a total of 52 stocks with a major exposure of 18.65% to the Engineering sector. For the Equity Investments, the fund is invested predominantly in Small Cap stocks with a portfolio exposure of approximately 79%(higher than the category average) & the rest of its assets are invested in Large & Mid Caps ensuring liquidity needs. The Fund’s Top 3 major shareholdings include exposures in Dixon Technologies, Hawkins Cookers & Elgi Equipments. Along with the equity investments, the fund has approximately 3.9% of its portfolio as Cash & Cash Equivalents.
  • Consistency: The fund manager has been able to generate alpha for the 4 years out of the last 5 years calculated for the annual returns. Alpha is the excess returns generated by the fund over the benchmark returns.
  • Volatility: The fund has a lower standard deviation(24.94) as compared to its benchmark i.e S&P BSE 250 Smallcap (28.19) & category average(25.38) calculated for the last 3 years. The standard deviation of a fund essentially denotes the volatility of the fund. A lower standard deviation than the benchmark & category average would mean that the fund is expected to be less volatile as compared to others.

Another risk measure Beta which denotes the sensitivity of the scheme’s returns against the market ups and downs is 0.84 calculated for the last 3 years which is slightly less than the Small-cap category average beta of 0.89. This means that the fund is expected to exhibit lower volatility than its category average. 

  • Valuations: On the valuations front, the important valuation metrics like P/B ratio(2.19) is higher than the benchmark’s P/B of 1.18, P/E multiple(12.38) which indicates the investment strategy followed by the fund is currently lower than the fund’s benchmark i.e S&P BSE 250 Smallcap Index P/E multiple of 24.70. Lower P/E multiple metric than the benchmark states that the fund’s underlying stocks have been undervalued as compared to the benchmark’s valuations for which the fund would have the potential to generate good returns over the long periods.

3. Axis Small Cap Fund

Axis Small Cap fund is one of the top-performing funds in the equity smallcap funds category. The fund managed by Mr. Anupam Tiwari since October 2016 has been able to comfortably beat the returns of its benchmark & category average returns by good margins.

The fund has delivered extraordinary returns of around 16.91% since its inception in November 2013. 

Worth of Investments  

  • A Lump Sum Investment of Rs.1 Lacs for 5 Years would have grown to Rs.1.47 Lacs.
  • SIP Investments of Rs.10,000 every month for 5 Years would have grown to Rs.6.81 Lacs.
 3 Year Returns5 Year ReturnsAUM(Cr.)
Axis Small Cap Fund3.74%7.96%2,124
Category Average-5.50%3.66% 
S&P BSE 250 SmallCap TRI-9.88%0.88% 

Returns as of 24 June 2020

Analysis

  • Portfolio: The fund has a well-diversified portfolio of a total of 47 stocks with major exposures to the Construction & Financial sectors. For the Equity Investments, the fund has been invested predominantly in Small Cap stocks with a portfolio exposure of approximately 73% & the rest of its assets are invested in Mid Caps ensuring liquidity needs. The Fund’s Top 3 major shareholdings include exposures in Galaxy Surfactants, City Union Bank & Aarti Industries. Along with the equity investments, the fund has approximately 13.1% of its portfolio invested in Debt securities.
  • Consistency: The fund manager has been able to generate alpha for the 4 years out of the last 5 years calculated for the annual returns. Alpha is the excess returns generated by the fund over the benchmark returns.
  • Volatility: The fund has a lower standard deviation(23.10) as compared to its benchmark i.e S&P BSE 250 Smallcap (28.19) & category average(25.38) calculated for the last 3 years. The standard deviation of a fund essentially denotes the volatility of the fund. A lower standard deviation than the benchmark & category average would mean that the fund is expected to be less volatile as compared to others.

Another risk measure Beta which denotes the sensitivity of the scheme’s returns against the market ups and downs is 0.78 calculated for the last 3 years which is significantly less than the Small-cap category average beta of 0.89. This means that the fund is expected to exhibit lower volatility than its category average. 

  • Valuations: On the valuations front, the important valuation metrics like P/B ratio(2.75) is higher than the benchmark’s P/B of 1.18, P/E multiple(17.40) which indicates the investment strategy followed by the fund is currently lower than the fund’s benchmark i.e S&P BSE 250 Smallcap Index P/E multiple of 24.70. Lower P/E multiple metric than the benchmark states that the fund’s underlying stocks have been undervalued as compared to the benchmark’s valuations for which the fund would have the potential to generate good returns over the long periods.

More Information:

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