Does the large size of SBI Small Cap Fund bother its fund manager, R Srinivasan?

R Srinivasan, CIO-Equity, SBI MF

How much is big enough? For SBI MF, a corpus of Rs 16,089 crore for a small-cap fund might sound big, but that hasn’t nudged the fund house to shut the gates totally. It has left the door slightly ajar. At present, you can only invest up to Rs 25,000 per PAN (Permanent Account Number) on new SIPs (systematic investment plan) in this scheme. R Srinivasan is the Chief Investment Officer -Equity at SBI Mutual Fund, and is known for his expertise in the small cap stock space. He is also the manager of SBI Small Cap Fund.

This scheme has generated a 10-year return (CAGR) of 26 percent; second-highest in its category. That has likely helped the scheme attract more investors, too.

With an AUM of Rs 16,089 crore as of April 30, 2023, SBI Small Cap Fund is the second largest in its category. That huge corpus is not an ideal place for a small-cap fund to be in. This has led SBI Mutual Fund to impose a cap.

So what lies next? In February 2021, R. Srinivasan was appointed as Chief Investment Officer (CIO) - Equity at SBI MF after Navneet Munot- the fund house’s erstwhile CIO- left the fund house to join HDFC MF, as its chief executive officer.

Srinivasan spoke to Moneycontrol’s Maulik Madhu on his investment style, what returns to expect from his small-cap fund, why he’s bullish on financial services and more. Edited excerpts:

SBI Small-cap fund is known for its aggressive strategy. What's your investment style? Anything special or different in your strategy here, than managing other schemes?

As a house, you can say we think in terms of an absolute return and a relative return mindset. Call it a core and satellite if you like. All of this is in a long-only context, meaning we don’t take substantial market timing calls (except in explicit asset allocation strategies).

The core philosophy is as cliched as it gets — we try to buy a good business run by good guys at reasonable valuations. However, there is a lot of mental effort in trying to figure out what constitutes a good business model, what you mean by good management and valuations, which needless to say, goes beyond just optical PE (price-to-earnings) or PBV (price-to-book value) multiples.

Our satellite philosophy looks at incremental fundamental change, market expectations, momentum, and relative valuations; we also run a quant model that tries to capture this into an objective ranking structure.

If I had my own way, I’d just follow the core philosophy. But, since we run open-ended fund structures with daily NAVs, we run some combination of these two philosophies. The Small Cap Fund is benchmark- and sector-agnostic and it follows a bottom-up style focused on stock picking.
Small caps tend to lie in the higher-risk, higher-return spectrum not only due to stock volatility but also due to the nature of the beast — vulnerable business models, scalability challenges, lack of management breadth and stock liquidity.

While the variables underlying the investing philosophy don’t change, how you put them together in terms of their relative intensities determines when you decide to buy a stock and how much of it. There is also the research arbitrage in small caps, which pays off if you put in the time and effort; the efficient market theory is a lot more in play in large caps than lower down the curve

Does the large size of the SBI Small Cap Fund bother you? While lumpsum investments have been stopped and new SIPs have been capped, what’s the way forward for existing investors? 

Yes, it does. Just to clarify, new SIPs have been capped at Rs 25,000 per PAN. Our average SIP size is a fraction of that, leaving a lot of room for investors on average to top up their SIPs.

Typically, and "subject to market risks", you may think about market return expectation as a multiple of nominal GDP growth. However, initial conditions are relevant. Given that valuation levels are not exactly conducive, one may expect returns to be far more modest, in the range of say, 10-13 percent, over the next 10 years.

Going by the fund factsheet, capital goods, consumer durables and consumer services account for 45% of the Small Cap Fund portfolio. In the Focused Equity Fund portfolio – there is no capital goods company, and the other two industries account for about 6% of the portfolio. Please explain your view on these industries.

Both funds are run from a bottom-up perspective. The sector underweight and overweight is a function of stock selection. They don’t necessarily indicate our view on the sector.

Having said that, we like Industrials given the expected momentum in economic growth, a well-capitalised financial sector, and the impetus to manufacturing via the PLI (production linked incentive) schemes. Most of the industrials we own in the Small Cap Fund are small illiquid stocks that are not scalable in the Focused Equity Fund because of its size.

SBI Focused Equity Fund has invested nearly 37 percent of its corpus in Financial services sector. Why such a high exposure to a single sector or theme?

We like Financials. It probably is the only sector that seems to offer ‘growth at a reasonable price.’ The key theses being a potential pick-up in the economy, a well-capitalised balance sheet and zero hangover from a credit cycle. We have internal constraints on absolute sector exposure else we would have owned more.

Many market people swear by the need for global equity exposure for diversification. Do retail investors need global (or even just US stocks) equity exposure or is Indian equity exposure enough for them?

Well, most Indian investors are not even diversified across asset classes. For those who have a large equity exposure, maybe it helps. But, more than the need to diversify, global exposure makes sense from a bottom-up perspective. You are effectively accessing a larger universe of stocks — there are mega trends underway that don’t find representation in India. And in a market that is so dynamic, it is easy to imagine finding a stock that looks better than what’s available in India.

While we do expect growth in India to be higher, it is pertinent to note that the US, for instance, has outperformed emerging markets over long periods on currency adjusted returns.

How should a retail do-it-yourself investor go about shortlisting a good small-cap fund? What are the key metrics to look at, and the minimum horizon to have?

Never ask a barber whether you need a haircut.

As with any fund selection, the key metrics to look at are: the pedigree of the fund house, the quality of the team and its attrition, the philosophy of the fund, a check around whether they do what they say they do, past performance, expense ratios and risk metrics. And as with any equity fund, the minimum investment horizon should be 7-10 years.

Also see: MC30 List of Funds

What’s your personal asset allocation like — equity, debt, etc?

It’s almost entirely equity if you exclude the insurance premiums and real estate. I’m a net saver and hope to remain so for the next 7-8 years, if not more. Given the inherent compounding in equity, it makes no sense for me to allocate to debt.