The Mutual Fund Show: Is It Time To Book Profit In Small-Cap Funds?
The BSE Smallcap Index has more than tripled from its March 2020 low. But will the rally sustain? Should investors consider small-cap funds?
Two financial advisers BloombergQuint spoke with on its weekly special series The Mutual Fund Show differed on whether investors should take money off the table from small caps. Rather, they suggested booster systematic transfer plans as a good investment option.
According to Prableen Bajpai, founder of FinFix Research and Analytics, as the S&P BSE Smallcap Index has surged 213.48% since March 2020, there is merit in the argument to book some profits in such funds.
That, she said, was because:
The Nifty is up 133% in the same period, showing that small caps have dramatically outperformed.
Small-cap funds are significantly more volatile than other diversified schemes.
Though Kshitiz Mahajan, co-founder of Complete Circle Capital, agreed with Bajpai’s assessment, he advised investors, with an investment horizon more than five years, to not take money out of small-cap funds.
And even if some portion of the funds are sold, the money should not be invested in debt products but kept in lower-volatility products such as balanced advantage funds, he said. That would ensure that the equity investments are done at the right time and won’t correct as much as small-cap funds when the market falls, Mahajan said.
ICICI Prudential Asset Management Co. has launched a booster STP. In this plan, SIP instalments get deducted from the source scheme based on market valuations. The booster STP works on a proprietary model of the AMC, where the Equity Valuation Index is derived by assigning equal weights to price-to-earnings ratio, price-to-book ratio, G-Sec*PE and market cap to GDP.
Bajpai and Mahajan said it’s a good option for investors who have a lumpsum of money to invest and are looking for an optimal long-term investment strategy. The human bias of fear during a downturn and greed during an upturn, according to them, will get negated by the mechanical way in which the AMC will follow the EVI.
Watch the full show here:
The question that is probably on the top of mind of everybody is whether here should I book profits, and more so, at the broader end of the spectrum? So for mutual fund investors, the question that comes to mind is that, forget large-cap funds, but from my mid-cap funds from my small-cap funds or if I have a flexi-cap fund, which has got a higher exposure to small caps and mid caps, should I take some money off the table, whether partially or fully? What are your views and why?
PRABLEEN BAJPAI: This one is always tricky to answer. I think a one-word answer would be yes, and I'll give you some data here. See ideally when we say that whether you should be booking profits or not it actually depends on how far your goal is. So, if your goal is, of course, like it's two years from now, definitely anybody should be booking their profits. If the goal is a little away let's say eight to 10 years of course they don't need to worry but of course depending on their own personal risk appetite and other things, partial profit-booking can be done. Now, since the lows of March 2020 we've seen the BSE small-cap index up by 213% till yesterday, and the Nifty during the same time period has been up by about 133%. So of course, it's a huge gain that the small-cap index has made. The gains are really large, and the fall is also quite hard, so we've seen falls up to 72% in 2008 and then 40% subsequently, in 2011 also. Two things here, when we're talking about whether they should be booking, if you look at statistics valuation wise of course P/E is not the only criteria that has to be seen, but that's the only way of keeping your emotions slightly aside, so P/E or P/B or price to book value, these two matrices can be seen and going by these two, there is a bit of overvaluation currently. I do feel that at the P/B of 3.02 which is currently for the year 2021, it is the average of the month, it is much above 2017, it was a 2.37, when we did see a small-cap rally, so going by these figures, the data that we have, yes, some profit booking can definitely be made. Having said that, one more thing, all this is actually for the index. So we are talking in relation to an index, an index is not a very true representation, especially in the small-cap space where there's a huge scope for stock-picking and the individual data, scheme-wise must be analysed by the investor him or herself or by their adviser before taking a call because there can be huge gaps there between the P/E for the portfolio of the certain scheme and what the index is showing and that the broader markets are showing.
Kshitiz, you guys are known to be all out-equity people. What is your sense here and again, the question would be why or why not?
KSHITIZ MAHAJAN: I think that's a valid data point presented by Prableen, my take here is that when we talk about somebody who's does not buy and hold, forget about small cap, mid cap or any cap is not for that person. It could be the people who keep on talking about what type of returns they're generating, but people don't focus on P, that’s the future value formula, FV= PV (1+r)n, the focus should not be on R, it should be on P. So, somebody who will not buy and hold for more than five years, seven years, then small cap for sure not. If he is there in that investment for the last one to one-and-a-half years, it will be a dream run for the small-cap sector. Having said that they have not done well since 2017 December onwards, they have not done well at all in last two-and-a-half, three years. So yes, one can look at moving out of small cap. But then, depending on what type of goal he wants to achieve at this point, one is wealth creation and he doesn’t want to have a lot of risk on the table by investing in small cap, he can move to a multi-cap fund or maybe a large-cap fund but if he has a limited time frame goal, let's say the goal is for three years, then rather just park it into any debt funds or than an instrument, he can move to a balanced advantage fund. Now, the beauty of all balanced advantage funds right now, except for Edelweiss, where they have a daily averaging of equity debt allocation, other BAFs are at almost 33-34% of the equity allocation. So if market will fall, automatically your equity participation will increase and we all know there are two expanding asset classes, equity and real estate, debt will not give you much more than 5.5%. So, you can look at BAF, second, if you have a horizon which is close to five years, then move to a multi-cap fund or a large-cap fund. Otherwise, if you have horizon which is less than two years from here onwards, then my suggestion here is that just move out of equity as an asset class because what we have seen in the last one-a-half years is not going to get repeated in the coming times. So, one should be aware that small-cap investing, the bracket which now the regulator has given that from the 250th company to the 500th company for small-cap investing, so market cap begins from 10,000 crore and for most small-cap investors, they all can invest up to 2,000 crore. So, there are certain good businesses and funds in that basket, but you should have time which is in excess of six to seven years, and you can look at maybe 22-23% compounding on this sector.
Kshitiz, the person who is investing, they are not a buy and hold kind of an investor. In which case, are there still small-cap schemes or small-cap funds, which are doing their work in a risk-adjusted fashion wherein even at these elevated levels, it might be prudent to keep some money on, not maybe the entire corpus but some money can be kept invested because it's futile to time the market?
KSHITIZ MAHAJAN: First of all, let’s understand what the small-cap regulations are. if you are investing Rs 100 in small cap, 65% would need to be in the small-cap space only but the remaining 35% can shuttle between your large-cap or mid-cap baskets. There are certain funds which are grown in size and I would like to name theme especially which is DSP Small-Cap, HDFC Small-Cap and your SBI Small-Cap where one thing is that they have a lot of number of stocks in the basket to diversify the risk, second is, they have good allocations in the large and mid-cap space so. So, they are using it well. I see that this China Plus One, interest rates which are low, or the India focus, growth direction of the government about how they want to go about it and a lot of other things are moving these entire markets in a very good direction. Having said that, the market will remain the same, I can’t say but if you have some time on your side then maybe you can book the profit but keep the money intact in the space because this space is very much capable of creating 3-4% delta over your large-cap basket. So, yes, I agree with you on that.
Prableen, are there funds at the small-cap end where you believe they are doing exemplary work and people should keep them in mind if not now, then maybe of lower NAVs if the markets were to correct?
PRABLEEN BAJPAI: Why not, I think small-cap is a great space to enter when markets are really down because the fall is so much more actually. It can really work some of the funds I think investors could keep in their minds are probably the SBI Small-Cap, it's been a very consistent performer. Also when it comes to small-caps, I feel that I personally would avoid funds which have a very short-ish kind of a track record, because it's really important to see how the fund has fared over the different cycles. So, if it has gone through the 2008, 2009, 2011 these time periods, it will be very good. So, funds with a long-ish time that they've covered, DSP is one fund and Axis. So, I think these three currently.
Kshitiz, about this booster STP thing that I think I ICICI has come out with, can you tell us what this is about? Is that a good strategy, and throw some light on it and what kind of investors is it suitable for?
KSHITIZ MAHAJAN: This show is watched by a lot of people, so just to make things easy for everyone. There is a different platform through which you can invest in equity in a staggered manner one is a systematic investment plan, the money gets debited on a defined date from your bank, but not a bank holiday on day after that. Every month, let's say 5000 rupees keeps going in a scheme that you define. The other way is a systematic transfer plan, which is called STP, this is not a very long-ish process which you go for. It can be for six months, 10 months or 12 months, let's say maybe for a couple of years, you put money in any of the debt schemes. Let's say liquid fund or ultra-short term or whatever fund scheme you define and on a monthly basis, on a given date money gets switched from one liquid fund to the given equity scheme. It can happen to a debt scheme also. The facilities is for across the street. So, this is called STP. Now, normally if, let's say I have put in Rs 12 lakh , and I want to divide my allocation in these levels in the next 12 months, I will say one lakh each depending on and then there will be some surplus money because of the liquid money acquisition which will remain and we can switch later on but this is a very beautiful concept which ICICI has come up with. It's called booster SIP. It works on a model, which is called equity valuation index which is on the basis of your price-to-earnings, price-to-book value, your G-sec*price earning and market cap to GDP. There are four parameters on which it works, and all these parameters define a range at which the equity valuation is, and it varies between 0.1 to 5. Let's take for example, if one lakh every month will go, if you want to put this money right now, the valuation metric will say, just put Rs 10,000, not Rs 1 lakh because markets are very high valuations. Now, the same thing but if you go back to March 2020 and they do this on every 28th, they will say put 2,80,000 on March 28 because the valuations were very cheap and because March 24 was the day when the markets were low, and then it recovered a bit. So, then the valuation was this. Now rather than just doing this in a very mechanical way that every month on 28, Rs 1 lakh will go but this allows customers or allows any investor to encash on the markets given market values. So, if I come to you, you are very knowledgeable or you understand equity well, but let's say if you are not a part of this industry, I'll come to you and say, the market is down, we can switch the money now. At 7.400 levels how many people were actually participating in the equity market? You will not do but if there is a process which is set, because there is no emotion in that, there is a valuation matrix, automatically, rather than Rs 1 lakh your money gets deployed at 7,700 or 7,800 level of Nifty, Rs 2,80,000. This is the best thing where emotion doesn't play a role and automatically depending on the value metrics, your money keeps on going in our equity portfolio. This is about how it works and I think it's a beautiful concept which ICICI has come up with. I would urge other AMCs to start with this, they can't do this but it's actually a very good concept.
Prableen, you want to add something to this and of course also couple it up with what kind of investors would this be suited to? I mean specific kinds or is it for everybody?
PRABLEEN BAJPAI: Absolutely, people who want to invest right now somewhere there would be hesitation that markets are at all-time high. I think this is an amazing concept because like Kshitiz said it takes away all the bias, basically the emotion, the behavioural bias that goes. Second, now there is an issue with switching money, if I have to do it at the individual level, the day I made the switch and day I get the NAV, there's a lag and all but all that is taken care of. We are all busy in our lives so on a day-to-day basis if somebody is actually tracking markets and trying to make that shift it may not work. So, the process is automated, I think interesting, and it also can extend the tenure if there is not enough opportunity. So, it's not like within 20 months the money has to be deployed, it will extend the tenure as well. So, even I would agree I think all AMCs have it standardised and as a tool, it should be there, this kind of a mechanism to move into the markets when valuations are more lucrative. I think it can really help and its interesting concept because EVI is also based on four different parameters, so it's not only on one thing, it's an equal weighted thing between those four parameters. The back studies they've done, actually, the testing does show that they've been able to achieve about 2% difference in returns during the time period that ICICI had actually done the thing. Second, what happens is that we set an STP, and we keep buying it in higher markets. So, we just pick like it has to be weekly let's say 20,000, that doesn't happen. So, you're not averaging upwards at least.
KSHITIZ MAHAJAN: Just to add to what you said, in stocks, I think people should have a target of not price but number of stocks. With good businesses how much percentage you are weighing, it can be in bitcoins normally when you buy one lakh of Bitcoin, it comes one point zero, zero, zero and then some number. I think the best part is, how much business do you owe to that if you like that business, and eventually the pay-out is eventually going to be good.
Is the summation of this conversation that it's a good scheme and people should take advantage of it?
KSHITIZ MAHAJAN: Now, I sincerely feel if you have a lump sum money to deploy and markets are where they are and very rightly put by Prableen also, rather than putting all the money in a staggered manner, in the same fashion mechanically about Rs 1 lakh every month depending on what value it throws and the value is 0.1, so your upward averaging is not happening. It is only Rs 10,000 which is moving and when the market falls, it will take care of it.
Prableen what do you make of the risk management rules by SEBI? Was it something too harsh? Is all of this leading towards more transparency and is there more that could have been done but wasn't done?
PRABLEEN BAJPAI: It is a very extensive 48-page document. So, the gist of it of what I've understood, of course, there is a huge focus on one thing which I really liked, is the huge focus on identification and management of risk. They've actually spelled out all different kinds of risks from creditors to liquidity to governance to even talent, so when you have a person, an AMC even has to plan for who's going to be next if that person leaves or something happens so there's a talent risk also. They have covered these different kinds of outsourcing, multiple risks and they've given some interesting solutions or proposals there, some of them of course are mandatory, some of them are recommendations. So overall, a lot of focus on how risk has to be identified, also a lot of it has been there earlier also gradually because in the last two years, SEBI has come out with so many circulars on bringing in more transparency, increasing compliance, regulations but it also clearly spells out the roles and the responsibility. So, it's very well defined and simple things like let's say investor concentration or a distributor concentration for an AMC, those things also need to be tracked very closely. So overall I feel AMCs as it is, are very highly regulated but I think it will further boost the protocols that they have, it will become more standardised across AMCs with these mechanisms. In total, I would say that from an investor point of view, there’s nothing really much that could change at the end but of course, a lot of work that probably AMCs have to do.
Kshitiz, your views here very quickly.
KSHITIZ MAHAJAN: Normally, we say that we go level two, this is SEBI going level three and I should compliment SEBI. Very rightly put by Prableen, I’ll not speak of what she has already explained. From an investor point of view, his money is safer because every compliance, every operational part, every cyber part, whichever part is having better security or maybe a better compliance risk officer attached to that, it becomes safer. Second important part is, I think I used to work in UltraTech Cement, Gurmeet used to work in ACC Cement. So, for both of us, if you see a cement plant or any company factory, there used to be a lot of employees, but the total strength of employees is 10% or 8% of workers. That is how it is. So, AMCs need to have a lot of people on their corporate office side as well as on the manufacturing side as well as on the risk management side because this is the main thing which they need to understand. Returns generating is one part, keeping client interest in all parts whether the compliance side, operation side, type of stock they are looking at, the type of succession planning you're doing for the company. Tomorrow if any CIO the key man who is managing the show, needs an AMC, what is going to happen then? So, have you planned that? That is something that we have defined, there used to be a chief risk officer, CRO, and they have defined responsibility for each and every officer—CEO, board, CIO and at every level so that it becomes more compliant, it becomes more robust in terms of its approach towards clients and client interest and money is in better and in safe hands. So overall this is a very welcoming step by SEBI.