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Small-cap funds are not suitable for all investors

LiveMint logoLiveMint 13-06-2017 Kayezad E. Adajania

IDBI Asset Management Co. Ltd is India’s 24th largest fund house, with assets under management of close to Rs8,000 crore. The asset management company (AMC) has launched a new scheme called IDBI Small Cap Fund (ISCF). 

ICSF is an equity fund that will invest in equity shares of small-sized companies. For purposes of this fund, a small-sized company is defined as one whose market capitalisation, at the time of investment, is equal to or lower than the highest market capitalisation stock in the Nifty Small-cap 250 Index.

The fund will invest at least 65% of its corpus in these companies. It can invest in other-sized companies, such as large- and mid-sized ones, up to 35% of its corpus.

The fund will follow a bottom-up stock picking strategy; which means, it would pay more attention on identifying the stocks, instead of identifying which sectors to invest in. Unlike many other small-cap funds that were launched in the past few years—which were closed-end—ISCF is an open-ended fund. 

A small cap fund can work wonders for your portfolio if it is used wisely. Financial advisers suggest small-cap funds for portfolios of many investors, especially those portfolios that are diversified through a bunch of large-cap, diversified and mid-cap funds.

Till about 3-4 years ago, most of the fund houses used to invest in small-sized companies through their mid-cap funds. But the equity market rally that started in 2013 in anticipation of Narendra Modi winning the central government elections (held in 2014) led the equity markets to rise on the hope of an economic recovery.

In the year of 2014, small-cap funds gave 90% returns on an average, as compared to 72% by mid-cap funds and 41% by large-cap funds.

Going by the figures above, ICSF carries with it the promise of high returns. But don’t get pulled in only by the expectation of high returns. Small-cap funds are risky and can be volatile. Also, small-cap funds can get very illiquid.

Large-sized small-cap funds, such as DSP BlackRock Micro Cap Fund, have been known to stop subscription when they reach a size where fund managers find it difficult to deploy money. However, ISCF’s fund manager V. Balasubramanian, who also heads the equities team at IDBI AMC, told us that even in these rising markets he is confident of finding small-sized companies at reasonable valuations. 

Small-cap funds can add variety to your portfolio but they come with fair amount of risks. It’s very important, therefore, to ascertain two things.

First, ascertain your asset allocation and risk profile. If you cannot fathom the volatility that a small-cap fund can bring to your portfolio, avoid small-cap funds altogether.

A well-diversified, mid-cap fund with a good track record can suffice.

IDBI Asset Management Co. Ltd has an average track record in equity funds. Its flagship fund, IDBI India Top 100 Equity Fund has been a mixed-bag: in 2016 it returned just 1.55% and underperformed its benchmark index Nifty 100 index, which had returned 4.26% return in 2016. IDBI Equity Advantage Fund’s track record too has been unimpressive: it lost 0.05% in 2016 and underperformed its benchmark index S&P BSE 200 index that gave a return of 4.52% in 2016. 

Our recommendation for ISCF is to avoid this fund.

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