The Mutual Fund Show: Don’t Be In A Rush To Buy Mid- And Small-Cap Funds, Say Two Advisers
Mid and small caps tumbled more than 5% from weekly highs. Reasons cited include a recent rally in such stocks, BSE Ltd.’s fresh price caps to contain volatility and profit-booking. And it would have scared small- and mid-cap fund investors.
Some of this correction was warranted because of the steep rise seen in the last 18 months, according to Kshitiz Mahajan, co-founder, Complete Circle Consultants; and Mrin Agarwal, financial educator and founder, Finsafe India.
Investors should be careful while investing in the small-cap funds, Agarwal said on The Mutual Fund Show. He advised waiting for some more correction before entering in stages.
Mahajan said there has hardly been any noticeable movement in mid and small caps in the last five years. He advised to start investing in small-, mid- and multi-cap funds as some of the good broader market schemes have returned 20% gains in the last 10 years.
He, however, suggested to stagger purchases over the next 10-12 weeks, and look at a horizon of six to seven years as that’s when a drawdown occurs. It can be brutal and a recovery usually takes longer than expected. Mahajan’s picks are Axis Smallcap Fund, DSP Smallcap Fund and Kotak Smallcap Fund.
The list of best-performing systematic investment plans in the last five years is dominated by technology funds: ICICI Pru Tech Fund, Quant Small cap, Tata Digital India Fund, Aditya Birla Sun Life Digital Fund and SBI Tech Opportunity Fund.
Mahajan suggested to stay invested and even add to these schemes as he expects the weight of technology companies in the market to move higher. Also, he said, tech firms in India will continue to remain profitable and thus gain market cap. He suggests Tata Digital India Fund and the SBI Tech Opportunity fund.
Agarwal does not suggest thematic funds and advised to invest in flexi-cap schemes that can include technology companies across market cap.
Watch the full show here:
Here are the edited excerpts from the interview:
Mrin, what's your view on the carnage that we’ve seen in the small-caps in the mid caps, and the subsequent NAV erosion, or if not erosion a dip that we've seen in some of the small cap funds? Is it a good time to nibble into them, say not in an SIP route but in a lump sum route, or would you believe that there may be some more to go for this, and therefore investors should buy the time? What should they do?
MRIN AGARWAL: I think you know we're seeing a very good correction and we're seeing some fair bit of profit-booking maybe also driven by the BSE circular that came out earlier this week which has some capping of price movements. I think it's a good thing because if you look at YTD, for example, the small-cap funds have risen the most and at a very fast pace. So, I think a good correction is always good. We’ve seen 7-7.5% correction in the recent past, so I think that's a good correction. I would still say be very careful about which fund you get into and of course, you must remember that with any small-cap fund your holding needs to be pretty long so don't get into it looking at some good short-term returns. So of course, you do your due diligence and as long as the holding is long-term, you might want to look at and at least keep money ready to start allocating if you see another couple of percentage dip.
But not allocate immediately, it might be good to see it for a bit longer?
MRIN AGARWAL: It might be good to see how the whole thing really plays out, I think we had a bit of a recovery today but might be good to see because the uptake has been really high, right? So, I think you're looking at 60% plus sort of YTD returns on small-cap funds. Again very typical of people to get into these trending funds so I think just wait it out a bit, a bit more fall I would say maybe another 4-5% and then look at entering in phases.
Should people who have either bought small-cap funds recently, or were hoping to buy small caps on any correction, use this as an opportunity or do you believe it's prudent to wait for a bit?
KSHITIZ MAHAJAN: I think Mrin has quoted it very nicely. My thoughts are that we are talking about that small cap has rallied in this year, calendar or let’s say since one-and-a-half year. But if you actually see last five years, hardly much of the movement is there. We have seen last carnage in small and mid cap when the regulation on how the funds have to be managed by SEBI, that was there in 2018 and that year we have seen, calendar year, returns for small cap at minus 57 and your mid-cap at minus 48. So, I still feel that there can be a little more opportunity which this carnage can give you further but yes, rather than waiting on the sidelines, once you start allocating—you already have 5-7% correction on the small-cap index and mid-cap index that itself is a good discount and if somebody wants to park Rs 100 on these funds, they’ll need to start at Rs 10-20 immediately. So yes, I don't know what is going to be the further discount on the markets but when you can see that there is a massive discount which has come in the last three, four days, one can start. Having said that mid cap, otherwise also are trading to a discount to Nifty — as on day to day also close to 18% discount to Nifty. So, one is that you keep on getting some allocation on small and mid caps and in your multi-cap allocation also. Having said that, if you see eight to 10 years’ return on all these indexes, it is an excess of 21-22%. So, if you have time on your side, which is an excess of six, seven years, small-cap funds you can invest in. The right strategy is to go slow, whatever funds you want to invest in and SIP is the right way, if you have lump sum money maybe stagger it over the next 10 to 12 weeks, that's what one can do.
Kshitiz, so mid caps may be at a discount but small caps are not at the discount, right? So, I agree that maybe if you look at the last five years, small caps may not have done as much but you have to buy the argument that small caps have been red hot for a while and in a corrective move, the NAVs could be much lower. So I agree that nobody can time the market, I'm just wondering if, just looking at the last two, three days, would it be better and again your answer doesn't have to be a yes.
KSHITIZ MAHAJAN: What you are saying is right, like the NAVs are not in line with what the markets are on. I was just going through a few funds, whether it's Axis small-cap or HDFC small-cap. So, the markets are at -6, -7%. NAVs are at -2, -3%. So, it might be a possibility that because cash flows are still coming, it's a flavour of the last one year that people are participating into small cap. There are a lot of SIP money which is going into the small cap. So, yes, one can go slow, so I'm saying, I will still say that stick to your asset allocation, we might see some more pain. That is what is more important. If you're underweight on small cap and you want to add, maybe this is a time you can start looking at it.
Kshitiz, if you had the liberty to talk about one or two funds in the small-cap side which you believe have done good work and you might be comfortable. The timing is left to the investor but the fund and why do you like it?
KSHITIZ MAHAJAN: I think, there are four to five good funds but there are a couple of funds that are better. I personally feel that they are good funds and I personally feel that they will do little better. Again, this is just my analysis and there's no recommendation, one is Axis Small Cap Fund, second is DSP small-cap and third is Kotak Small Cap. These are three funds which gives you a very good allocation, because as per the regulation 65% has to be in small cap and remaining allocation you can take in a mix of large and mid-cap basket so it has a very good allocation on the large-cap space when it comes to the balance allocation. So, I like these three funds in the basket. Having said that, if you're looking at small-cap allocation, my request is, we tell people that, please come for five years in equities. Small caps should be not for less than six to seven years because there might be an instance like 2018 or maybe 2021 where we will see a sharp correction on these indices. So these are my favourites.
Mrin, one or two funds that you like, they may not necessarily be the only funds and the timing is not necessarily the question right now. The names of the funds and why you like them?
MRIN AGARWAL: I like DSP Small Cap, I think it's been a good consistent performer. If you look at the quantitative ratios around it as well, I think this fund has done well and I like the strategy that they have.
Kshitiz, is it time to take the foot off the pedal, take some chips off the table, maybe redeploy that money elsewhere, or you're comfortable being staying invested in an IT fund?
KSHITIZ MAHAJAN: Just to give perspective on IT as a sector, if you actually compare the broader index and let's say, Nifty or S&P 500 of the U.S., just apples to apples IT allocation, I'm not talking about Nasdaq I'm talking about S&P 500 or let's say any European emerged economy. Apples to apples, IT allocation or technology allocation is supposed to be at 27%, we are at 14.5-15%. So, one is that we are still underweight on technology on an index basis also. Secondly, the last one year has been very clear that Indian companies, technology companies have proved to the world that they can work remotely and they can manage things from here, and we have a long runway in front of us. I've just done one analysis, I’ve personally evaluated 10-12 companies which are going to go places on the technology platform. I'm not here to give any recommendation of the stocks but I'm saying that one should actually start adding little more allocation towards IT. Again, when I say technology funds have done well and they will keep on doing well or whenever you want to allocate in a lump sum way also, just stagger it over the next 10-12 weeks. That is what you can look at doing. I think that technology is the future and in that there are a lot of good offerings in India right now which are available.
Mrin, what are your views here?
MRIN AGARWAL: I do also agree that the technology sector is certainly looking very good but as such, I do not believe in investing in sector or thematic funds. I think these funds are meant really for more advanced investors who are taking tactical bets in these particular sectors and who understand the risks that are associated with investing into a sector fund. In any sector funds are going to have a concentration risk, and even when you look within the IT funds space, you will see that the top 10 stocks constitute to about 65-75% of the fund. So, to that extent, these funds are highly concentrated which means high risk. So, clearly, it's investors who are wanting to take a tactical bet into these funds, who need to get into them and of course there is sector rotation and some years some sectors do well and in other years other sectors do well. So, obviously you need to time your entry and exit to that extent. I would say that if you're already holding a fund and you understand the risks associated and you're okay with the volatility, then hold on. But I would actually recommend that for others who want to take exposure to this sector and not as a tactical bet maybe. They could actually just go with the broad-based flexi-cap funds because those funds also have about 7-15% exposure to the IT sector and pretty much similar stocks that you would see in the top 10 within these funds and you could also look at some of the flexi-cap funds also have a lot of foreign stocks on the IT side as well.
Kshitiz, when I looked at the top-performing funds, among the names were ICICI Prudential, Tata Digital India Fund, Aditya Birla Sun Life Digital Fund, SBI Tech Opportunity Fund. Do you recommend one of these, or do you like some other fund?
KSHITIZ MAHAJAN: So, I like Tata Digital India Fund and I like SBI Technology Fund and the obvious reason is, I like both the fund managers’ and their strategy. Second is they have on a domestic platform allocation towards international equities also and they can go up to 20-25% international equities. Tata Digital right now has 6% but they are planning to increase it to 20%. So, it gives you a benefit reserve on the taxation part also because I know there are a lot of funds which offer you a fund of fund option and they are also good funds which they can allocate to U.S. and other technology companies, but then you get domestic taxation in these companies. SBI has 15% and it has the likes of Microsoft, it has Alphabet. So, they are companies which will and which can do well and I was talking to Sreenivasan and he was saying that he will take this up to 25% because eventually we need to maintain 65% domestic equities. I very strongly feel that it's not cyclical or it's not a fund where you have a rotation especially healthcare and technology both products because in the long-term, etc., that's a 15–16-year track record you will see that in these funds, right now the returns are looking fantastically well but otherwise also, these funds have done well. So, I think for a broader allocation one can look at and obviously, what Mrin is saying is right, you have to decide on your risk appetite and what type of asset allocation you can take.
Mrin, should people take exposure to credit-risk funds? Are they bad-mouthed for the wrong reason?
MRIN AGARWAL: Yes, so I think the entire sector has this whole overhang of what happened in 2020 within the sector also, there are funds that have actually done well, that have not had defaults. Again it comes down to your risk profile so you should and the investor should understand that these funds are going to buy primarily bonds which are rated below AA, which means that they are going to be high risk in nature and they need to be ready for that sort of volatility. So, you can get into a credit risk fund provided you have a five-year time frame, and when you are getting into this fund, look at how has this fund managed defaults in the past. Of course the good thing that's happened out of everything, that has happened last year due to the newer regulations that came in, a lot of funds cleaned up and maybe they're better geared now to manage credit and liquidity risks. So, check the liquidity, check the credit profile, check the fund managers’ experience in managing defaults and very importantly, of course moderate duration because at this point, you don't want to get into a fund that has got a very high modified duration.
Kshitiz, what about you?
KSHITIZ MAHAJAN: I'll just add to what Mrin said and I'll give you three steps, number one, obviously, depending on your risk appetite you can keep adding up to 8-10% of your debt allocation in a credit risk fund. Second, do a level two check on the papers which its holding, let's say, the funds which we normally look at, they are having 45-50% in government bonds or let's say in liquid papers. Third, go level two on AA side also you can see that what type of house companies are there like say for a Tata Group company is there or if a company which is backed by gold, or some other good business houses are there—chances for default might be a little less vis-à-vis other companies. Another thing, if your investment horizon is in line with what you call your modified duration or the added maturity of the paper of the fund, then things become much easier. So the ride is not going to be that smooth like a banking and PSU debt fund. Having said that, there is a spread of 125-150 bps vis-à-vis a banking and PSU fund.
So, what's the return that one can expect?
KSHITIZ MAHAJAN: Anything which is pre-tax close to about 6% and when you're holding for three years, it's a long-term 20% so you can actually look at 5.75% to 6%. If you get lucky if you get a mark-to-market again, that's a separate.
Mrin, do you have any credit risk fund that you are comfortable with, that you believe is safe?
MRIN AGARWAL: I wouldn't use the word safe for any credit-risk fund and I'll also give a disclaimer that I've invested in this fund for a very long period myself. So, I would say ICICI Credit Risk Fund, it's not had any history of default, modified duration I think currently is about two-and-a-half or similar to that. It’s not very concentrated in terms of holdings. So, I think that it’s a good fund to go with.