How has Nippon India Small Cap fund compensated risks with handsome returns?
Nippon India Small Cap fund, one of the top performing smallcap funds, has compensated risk with handsome returns over the long term. It is suitable only if you have the stomach for high risk and a time horizon of 10 years and more
Small cap mutual fund schemes have rewarded the patient and disciplined investor. These funds have given a 21 percent CAGR (compounded annual growth rate) over the last 10 years, outperforming mid cap funds (19 percent) and large cap (14 percent) funds. However, small cap funds are not for everyone. High-risk profile investors with a time horizon of more than 10 years can consider investing in the top performing schemes in the small cap category. Nippon India Small Cap Fund (NSF) is one of the top performing smallcap funds in the industry. It has delivered comparatively better risk-adjusted returns since its launch.
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Profile: Nippon India Small Cap Fund (NSF) invests at least 65 percent of its corpus in companies that are ranked within 250 in terms of market capitalisation. Fund managers: Samir Rachh (since 2017) and Tejas Sheth Size: Rs 28,779 crore; largest fund in the small cap category Suitable for high-risk investors
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Small cap stocks are more sensitive to macroeconomic changes that lead to more volatility in the short run. But prudent stock selection within the small cap universe and identification of stocks in the early stages of growth have helped top-performing schemes like NSF deliver better risk-adjusted returns over the long term. Performance as measured by 10-year rolling returns over the past 13 years (since inception of the scheme) shows that NSF delivered a compound annual growth rate (CAGR) of 23 percent, while the Nifty Smallcap 250 TRI (Total Returns Index) delivered 14 percent.
NSF has been consistent in delivering superior returns. It was mostly either a Quintile 1 or Quintile 2 performer within the category in the past. Prudent stock selection and solid execution strategy by the fund managers have helped to deliver better returns over time.
NSF has done relatively well across cycles. NSF has been one of the top three performers in the current volatile market where stocks across segments traded high. The gap in valuations between small caps and large caps and between small and mid caps has widened over the last 12 to 18 months. Fund Manager Samir Rachh says the profit recovery of smaller companies has been as strong as that of large companies, with the breadth of Indian earnings being at their best in over a decade. “The profit pool which the small cap universe offers is unique and perhaps high growing. Further, the balance sheets and governance standards are at par” he adds. Responding to whether this is the right time to invest in small cap funds, Ravi Kumar T V, Founder, Gaining Ground Investment Services, says that on the strength of a better growth environment, decent earnings from the strong results shown by the manufacturing and consumption sectors and an increase in household spending owing to higher per capita income, investors can invest in the small cap category for long-term growth potential.
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With a corpus size of Rs 28,779 crore, NSF is the largest fund in the small cap category and accounts for about one-fifth of the small cap category assets under management. Larger asset size has been one of the deterrent factors for small cap funds. It is challenging for these funds to churn their portfolio to keep up with market dynamics, leading to sharp short-term underperformance. Rachh explains, “major challenges in the small cap category is that liquidity tends to be poor and impact costs higher. You cannot churn the portfolio like other equity categories do. The best way in the small cap space is long-term investing and diversification. Since we want to associate with a company over the long term, we focus on the quality of promoters and good businesses. Entering at the right price also matters”.
As of May 2023, NSF has an over diversified portfolio, holding 171 equity stocks, of which 137 are small cap stocks. Rachh says, “The key to generating alpha is to be able to continuously bring winners into the top 25 stocks”. As per the latest data, about 34 percent of the assets were invested in the top 25 stocks holdings. A caveat to taking larger positions in small caps is that getting in is easy but getting out, tricky. Also, the probability of going wrong is higher in small caps compared to large caps. Rachh explains that like largecaps one cannot exit at will from small cap stocks due to liquidity issues. Therefore, one will have to be very careful of what one is buying, making sure to choose good companies that may not have to be sold or those that will certainly have buyers when they must be sold. Hence, investors in NSF should be prepared for short-term underperformance when markets are down.
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Over the last three years, NSF has not traded much and follows a buy and hold strategy. This is reflected in its turnover ratio, which was just 20 percent (as of May 2023), against the 34 percent average of the category.
NSF also invests 10-12 percent in large cap companies not only for liquidity but also for taking exposure in some sectors that are not available in the small cap space. It keeps 18-20 percent in the midcap space.
Prudent stock selection has helped NSF. Long-term holdings such as Tube Investments of India, Deepak Nitrite and Navin Fluorine International turned multi-baggers and rewarded the scheme. Its recent additions include Krishna Institute of Medical Sciences, Gateway Distriparks and Angel One.
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NSF can be part of your core portfolio with a time horizon of 10 years and more. Investing in a staggered manner is advisable at this juncture. Note, Nippon India Life AMC has stopped accepting lump sum investments into Nippon India Small Cap Fund (NISC) from July 7, 2023. The restriction will also apply to switch in transactions. However, fresh registrations through systematic investment plan (SIP) without initial investment or systematic transfer plan (STP) or such other special product shall continue with a limit of Rs 5 lakh per day per PAN. Existing SIP and STP will not be affected.
