#BQMutualFundShow: If You Own A Small-Cap Fund, Should You Be Worried?
Should you switch from small- and mid-cap mutual fund schemes?
ICICI Prudential Asset Management’s portfolio management services division recently decided to shut down two of its schemes focussed on small-cap stocks and return money to shareholders, signalling that valuations may have reached worrying levels.
Current small-cap valuations may seem daunting compared to broader markets and the fear that such stocks are illiquid may put investors ill at ease. But fund managers and investment advisors BloombergQuint spoke with, say there is no reason to worry about if investors are investing for the long term. What seems overvalued currently would be fairly valued in a few years.
IDFC Asset Management Company’s Chief Executive Officer Vishal Kapoor says investors should focus on corporate earnings as a key driver of stock performance. He expects earnings to grow at 12-14 percent for the BSE 200 universe. Besides, a lot of investors are coming through mutual fund advisors, who could guide them during a correction, he adds.
The second factor, according to Kapoor, is that a lot of money is coming through systematic investment plans, which can be deployed by fund managers when valuations are relatively cheap, thus providing support to the market. There is little possibility, he says, that investors will redeem their funds in droves in case of a meltdown.
Amol Joshi, the founder of PlanRupee Investment Services, says investors should not look at past returns in small- and mid-cap funds to invest in such schemes; a better idea may be to re-balance asset allocation. Joshi recommends the Birla Sunlife Frontline Equity scheme in the large-cap category, the Motilal Oswal Multicap 35 scheme in the mid-cap category and the ICICI Prudential Balanced Advantage as well as the HDFC Balanced scheme in the balanced fund category.
Watch the full interview here.
Here are edited excerpts from the conversation.
People say we have been seeing how multi-cap, micro-cap funds have performed but we are scared of putting in money right now.
Vishal Kapoor: There are two things I want to bring up. One is, investing by looking at historic returns is never a great idea, you have to look ahead. The second point is around allocation.
Too much of a good thing is not a great idea. You’ve got to be able to spread it out.
If you have a portfolio which is concentrated in small and mid caps alone, then it is a good time to re-look and say..I am missing allocation across a few other sectors in the industry. But if you are looking at investing in funds which are top performing and have given a 60 percent return in last one year and you expect that going forward, then that’s not going to be the case.
Is timing a good idea or you will say don’t try and time the market?
Vishal Kapoor: If your horizon is long term, then you should not shy away even now. Clearly, valuations are a bit rich. Buy, you should keep in mind that we are buying companies and not the index in most of the actively managed funds. If you find earnings growth, then why not. It is feasible for you to have a fund which can find some multi-baggers of the future, provided you are willing to ride out the cycle and generate good long-term returns. But the key is long-term allocation. If this is the only thing in the portfolio and you are going to get scared over 1-2 years, then it is not a good idea. But if it is a part of the portfolio and you are willing to stick it out then it is a very good strategy.
Is the time prudent to maybe not look at investing in mid caps and small caps even from a long-term perspective? Do you think in 2018 we will get a pullback?
Vishal Kapoor: While it is always tempting to predict, that yes wait for the pullback, the reality is none of us are able to time it. I meet investors who are waiting for the pullback from the last calendar year, and we lost out 40-60 percent returns depending on which fund or sector you were in. So, timing is a bad idea.
We have done a study on the last 10 years to see what's driving the price behaviour which we are seeing across the market. We often come to the conclusion that it is liquidity or trading led. There are sections of the market which have more demand than the supply. The reality in our study was that, if you looked at any company across sectors which gave 10-year compounded return of 17 percent or above, 70-90 percent of the price behaviour was explained by earnings growth.
In the medium and long term, you have to continue to focus on earnings growth and nothing else because that’s actually leading to 70-90 percent of the price behaviour which you see eventually.
Do you think earnings growth will take care of these worries even at the broader end of the spectrum and not just the large caps?
Vishal Kapoor: That is what the market seems to be pricing in. In our study, we noticed that since the last peak in 2008, we can look at the market in broadly two halves. The first half being the stable sector -- these are sectors which are agnostic to market cap or investment cycles like consumer goods, FMCG, IT, telecom, etc. and the other half of the market is the classic cyclicals like banks, energy, and utilities.
The stable part of the basket has actually been growing at about 15-16 percent. So, it is very healthy earnings growth. It is the cyclicals which have dragged the overall earnings down. Cyclicals have de-grown by 1-2 percent over the last 10 years. So, the average that we are looking at is 4-5 percent. If you have EPS at only 4-5 percent and prices run-up, it is leading to a very high PE.
But the market is essentially pricing in a rebound in the cyclicals. In the next 3-4 years, you will have very high earnings growth in cyclicals, probably led by banks which will no longer have to do as much provisioning. Infrastructure spending and higher disposable income will also aid cyclicals. So, these are a few areas where we think there will be a spurt in earnings. Therefore, over the next 3-4 years, the PE should normalise a bit. That is the hypothesis the market is based on today.
If the downcycle were to come about and if redemptions took place on a larger scale, then large mid-cap and small-cap funds might have issues in making the payment on time to investors even if the investments have been redeemed. Can you shed some light here?
Vishal Kapoor: We don’t have that problem. Our mid cap and small cap funds are very modest in size. So, we don’t see any issue on that front. We do see investor behaviour getting more and more mature. I hope that it is the case even now.
There are 2-3 factors which are driving it. Firstly, we have been seeing a growing number of investors, and the longer they stay, the more maturity and the experience they gather. If you have gone through previous cycles, you know that you just have to ride out the cycle. Secondly, the advisory and the distribution community has grown significantly over the last few years. So, we hope that there are a lot of investors who have someone to talk to during times of volatility, which has been missing over the last year. But as volatility returns, we are hoping that the investors will call their advisors or distributors and take guidance. Thirdly, a large part of the growth in the industry is SIP-led. One certainly hopes that it will be much longer and not as volatile in terms of flows. I don’t think we must expect too much redemption or volatility of that type.
Also Read: Why Mutual Funds Cannot Assure Fixed Returns
There is a belief that there may be a time correction rather than deep price corrections. For every correction which began in the last year and a half, we have seen buying come in very early. So, there is a fair amount of liquidity which is available for people to deploy. If you look at time correction, then any major upheaval in AUMs should not be something which we could predict.
If you are investing at levels when mid caps and small caps are at a significant premium and if there is a perceived risk coming in, then how does an average mutual fund investor invest?
Amol Joshi: People mostly choose mid-cap and small-cap funds when they are looking for an excess return over and above what the benchmark is capable of delivering. Anybody who wants to enter because of this reason is best served by two strategies. One is investing when you have reasonable valuation but today is not that time.
The second strategy is, take a staggered or measured exposure. There is a good tool in a mutual fund which is Systematic Transfer Plan (STP). If you want to invest Rs 5 lakh, you can have an STP of Rs 1 lakh per month or Rs 20,000-25,000 per week. And you can take that Rs 5 lakh exposure to a mid-cap scheme over next six months. That is the strategy which you can use when you are not totally comfortable with valuations.