This MC30 small-cap MF scheme delivers returns, despite a high-risk strategy SBI Small-cap fund is a high-risk, high-return fund has delivered commendable returns over long run. It is suitable for Investors with a high risk appetite with a time horizon of seven years and more. The scheme currently allows only systematic investment plan (SIP) subscription
August 13, 2022 / 11:04 AM IST
Small-cap mutual fund schemes are high-risk, high-return investments as they invest majorly in small companies, many of which are in the nascent stage of their growth cycle. They are more sensitive to short-term market gyrations; they leap during market rallies, but slump when the market corrects. But over the long run, say seven to ten years, these small-cap schemes beat most other equity categories and frontline indices by a huge margin. The SBI Small Cap Fund (SSF) is one of them. This scheme is part of MC30, Moneycontrol’s curated basket of 30 investment-worthy mutual fund schemes. As required by the market regulator, SSF invests at least 65 percent of its corpus in companies that are ranked below 250 in terms of market capitalisation. R. Srinivasan, head of equity at SBI MF and also the fund manager, has been managing the fund since 2013. SSF is the third largest small-cap fund in its category, with assets worth over Rs 11,646 crore as of June 2022. Currently, SSF allows only fresh SIP investments and has restricted any lumpsum subscription. Note that the monthly SIP instalment is capped at 25,000 per PAN.
SSF was initially known as the Daiwa Industrial Leaders Fund, a large-cap fund when the erstwhile Daiwa mutual fund launched it in September 2009. Following the acquisition of Daiwa AMC by SBI Mutual Funds in 2013, SBI MF changed its name to SBI Small & Midcap Fund, and managed the scheme with equal allocation to mid- and small-cap stocks. The scheme was again renamed and brought under the small-cap category during the re-categorisation process implemented by SEBI in 2018.
Small-cap stocks are more sensitive to macroeconomic changes, that lead to more volatility in the short run. But prudent stock selection within the under researched small-cap universe, and identifying stocks in the early stages of growth have helped top-performing schemes like SSF 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 SSF delivered a compound annual growth rate (CAGR) of 21 percent, while the Nifty Smallcap 250 TRI (Total Returns Index) delivered 11 percent. Srinivasan follows a bottom-up stock selection philosophy. “From a long-term-investing perspective, we try and buy a decent business run by good guys at reasonable valuations,” Srinivasan says.
“We follow a simple stock selection process that helps deliver better returns across equity market cycles”, says Srinivasan. He chooses good businesses that have competitive advantage, are able to generate a reasonably high return on capital, have low capital intensity, high cash conversion, pricing power, longevity and are scalable. Though the scheme underperformed its peers and the benchmark during the post-COVID rally that started in March 2020, it has managed to cushion the turbulence in the equity markets over the last nine months.
Notwithstanding the fact that the scheme has a large corpus of over Rs 11,646 crore, SSF has allocated an average of 74 percent to AMFI-defined small-cap stocks over the past five years. Interestingly, it has not invested in large-cap stocks for the last two years. Higher allocation to the small-cap space for a scheme with a large corpus like SSF seems to be a risky strategy. Liquidity is the biggest challenge in the small-cap space. It reduces the flexibility to exit at a reasonable impact cost. It may be a bigger cause for concern in a downturn. “The higher corpus also impacts portfolio sizing, especially because stocks in this space are quite illiquid. Liquidity or the lack of it impacts our ability to take risks and generate higher returns,” Srinivasan explains.
Over the past five years, average cash holding has been 7.5 percent. At times, it has exceeded 10 percent due to the allocation towards derivative exposure. Holding higher cash has never been a risk-mitigation strategy for this scheme. “Based on the view of the market and/or the availability of liquid stock ideas, and/or stock specific convictions, cash exposure may go up to 10 percent of the fund,’’ says Srinivasan.
Long-term holdings such as Rajratan Global Wire, Relaxo Footwears, Thangamayil Jewellery and Garware Technical Fibres have paid off well for SSF. In the wake of the recent correction, the fund has also added stocks such as Delhivery, Zydus Wellness, Nuvoco Vistas Corporation and Brigade Enterprises.
Small-sized stocks are more sensitive to the market gyrations. Also, illiquidity is the concern. How you adapt to changing market conditions has been one of the deciding factors for the outperformance of small-cap funds. Barring a few, most schemes in the category churn the portfolio actively. However, over the last 6-9 months, most of them seem to be following a buy-and-hold strategy. As of June 2022, SSF’s turnover ratio was 18 percent.
Average number of stocks was about 49 over the past year, one of the lowest among peers. “Our preference is for a lower number of stocks than 49. Liquidity constraints and a lack of higher conviction ideas have resulted in this higher number. It is a challenge, which is the reason why the fund is closed for lump-sum inflows,” says Srinivasan. Investors with a high risk appetite can consider investing in SSF with a time horizon of seven years and more through the systematic investment plan (SIP) route.