MUMBAI: Emerging Business Fund houses have lined up new product plans, with small-cap stocks making a comeback after a gap of two years. To name a few, the small-cap funds of L&T Emerging Businesses Fund and IDFC Asset Management Company.
The L&T Emerging Businesses Fund-Regular Plan-Growth Small Cap Fund has 90.43 per cent investment in Indian stocks, of which 70.2 per cent is in small-cap stocks and 17.82 per cent in mid-cap stocks. These are most suitable for those looking for short-term investments and high returns.
IDFC AMC has announced IDFC Emerging Business Fund, an open-ended equity fund that would invest at least 65 per cent in small-cap stocks. Analysts feel this is the right time to invest in small-cap mutual funds. With a dearth of small-cap launches in last two years, Indian markets had been largely oriented towards mid-caps. Gaurav Khanna, vice-president (research), Equinomics, said the small-cap funds had been out of sheen and hence, retail investors would like to test when they are back.
Traditionally, small-cap investments are suited for seasoned investors or those with high risk appetite. According to Arthlabh, a financial data provider, small-caps do provide opportunities to generate reasonable outperformance, but one has to be aware of large drawdowns, and liquidity and governance issues.
The “timing” and “time in the market” are extremely important to generate superior returns from small-cap investments, says Arthlabh. “Small-caps have seen significant price correction since 2018, and multiple pointers indicate that one should consider small-cap investments now. Investors should invest through lump sum and systematic transfer plans of not more than six-nine months.”
The underperformance of small-cap funds, as on December 2019, is a whopping 46 per cent versus large-caps.
There are three factors to consider while investing in small-caps: price, valuation and volumes. Equity market data shows that small-caps are trading well below their average discount, with their positive price-earnings (PE) ratio at 14.8, against a five-year average of 17.4.
Additionally, small-cap PE is now trading at a discount of 34 per cent to its large-cap counterpart, against the average discount of 15 per cent. Finally, when we compare the volumes in the small-cap segment, a bear market typically witnesses 65-70 per cent fall in volume at its peak, post which the turnaround begins. The current cycle has already seen volumes fall by 66 per cent from its early 2018 peak.