The Mutual Fund Show: Small-Cap Funds Can Be A Good Contrarian Bet

Gajendra Kothari: It depends on what is your underlying expectation from this category of funds. This fund is very good for investors who want to move from fixed deposits because of tax inefficiency and because rates are coming down. So, for first-time investors it’s a great option. Your time horizon should be between two and three years. Right now, why this category still makes sense though is in the last one year this category has given fabulous returns to the tune of 11, 12 and 13 percent. Even now there is juice left because spread between ‘AAA’ PSU companies and banks and the 10-year G-sec is still very high compared to all-time average. So, when the spreads compress, you get an additional kicker in the form of capital gains. So, from another one-year perspective, you will benefit from this compression. From a three-year perspective, you will completely be able to beat bank fixed deposits post tax. As a conservative investor and because you’ve seen a flurry of episodes in the debt category, people have become very risk averse. So, for them this is a very good category; it is a safe bet from a three-year perspective.

Amol Joshi: Sure. Banking and PSU the name may not inspire too much of confidence at this juncture. Now what we have to understand is that all the activity that you have been seeing where banking is not doing very well is on the equity side. This is precisely a debt fund. Banking and PSU as per the last SEBI categorisation say a debt fund that invests 80 percent or more securities issued by banks, PSU entities and public finance institutions. So, on the debt side, this sort of a debt portfolio is considered to be very safe. That runs slightly counter to the point that you made but I am sure that point was on the equity side. So, on the debt side, I agree to your view that this is probably a safer fund what you can think of.

Kothari: For a conservative investor.

Joshi: New fund offer need not be the criteria for you to invest. The reason is you can always go to an existing fund where you have a demonstrated track record of fund managers having been able to do justice to the theme of the scheme as well as the fund managers having been able to navigate various market peaks and troughs. So, that is my thought; unless there is something new on the table; it is not necessary to invest in an NFO. However, I have a slightly different opinion on Large & Midcap NFOs of Motilal Oswal. Currently, any of the large- and mid-cap funds that you will see, the ratio is probably skewed towards 60 percent large cap and 40 percent mid cap. SEBI says in a large- and mid-cap fund, minimum 35 percent should be in large and mid cap. Motilal Oswal at least in their NFO documents has mentioned that they will maintain exact 50 percent allocation between large and mid cap. So, if this is something that you find missing in existing schemes, where large caps are more dominant and at the same time, large caps currently are trading at a premium valuation. Reasons are known to us. Mid caps are not doing that well. So, if you earn more exposure towards mid cap, then you can look at this NFO.

Joshi: Yes. So, first and foremost, stock ideas we will only come to know when the first fact-sheet is out; probably after a month’s time. One of the largest or number one and number two large- and mid-cap funds in the category that are currently operational in the mutual fund space, they have a skewed distribution— 60 percent towards large cap and 40 towards mid cap. The NFO is going to allocate 50-50.

Kothari: It is different from other categories of large and mid cap because this is going to be a very concentrated portfolio of 25 stocks only. So, Motilal Oswal has this pedigree that they don’t want to be too diversified. So even if you see other funds focused at 25, mid-cap 30 and 35, they don’t go beyond 35 stocks. So, of course, it is only meant for an aggressive investor. The entire position is in 25 stocks. So, for somebody who wants aggressive returns, all the other large- and mid-cap categories are diversified funds—may have 50-60 companies. So, this in that way is quite different. But I would still like to give my money to the existing fund; mid-cap 30 or multi-cap 30 because the portfolio is going to be a mix and an extract of multi-cap 35 portfolio. So, rather than going to a new portfolio and the fund manager in this case is new fund manager compared to the other funds. So, for the moment, I would like to stick to the existing fund, not that this fund is inferior. Give it some time, look at the portfolio quality and then take over.

Kothari: So, I would take a tactical call. This type of investment fits in a very tactical part of your portfolio because they are all slaughtered right now, these stocks. So maybe from a six-month or a one-year perspective, go in and make some money out of it because two years back, the first slot came and still it is minus 5 percent. So, from a quality point of view, I think other funds— the normal funds—are better because this is just a passive fund with no underlying objective. It is a mix of 20 stocks. I saw the portfolio of the previous one; the five stocks comprised 60 percent of the portfolio, it’s highly skewed. So, for a layman investor, I would say stay away. But somebody who wants to play and make a tactical call, it makes good sense.

Joshi: What I think about Bharat 22 is that it is an artificial construct. It is an artificial index. It is not India’s top 30 stocks which would be at BSE. It is not top 50 stocks—that would be Nifty 50. These are simply put; these are 22 stocks from which the government wants to exit. Now, are you planning to buy those 22 stocks only? Then Bharat 22 is for you. But if that is not your objective, if you are not keenly looking to buy the stocks that are underlying and held in this ETF, then you should simply give it a pass. Although, I should not strictly compare Bharat 22 returns with Nifty returns but this fund has underperformed Nifty in all points of time except maybe for a one-week or one-month duration, which is not the duration to evaluate any equity fund. So, I would say, most common investors are better off in an index fund or even on the passive side. I mean, on the active side, most common investors are better off with a multi-cap fund. There is no real need to look at Bharat 22.

Joshi: If you see the last time NFO came, 32,000 crore subscribed in this. Most people came for that discount of 3-5 percent. But, very soon this kind of ways weigh off. So, when you make investments in mutual funds for a long term, these 2-3 percent don’t matter. The portfolio quality has to be good and you can see what harm your portfolio has done in the last two years- vis-à-vis the long term. I am not saying other funds have beaten Nifty. They have not. But at least there is a theme, there is an underlying objective. As he said, it is a construct. There is no rhyme or reason behind why these 22. Just because the government is offloading it, doesn’t mean you should own it.

Kothari: When this happened for the first time with SLM, it was the first in the industry. Nobody knew how to respond. In the investors best interest, what the fund managers and the fund companies did was right. Rather than losing money and going for that fire sale of shares. They discussed with promoters and arrived with a solution. But I feel that, at that point of time, it was a sensible decision but now, what SEBI has come out with is very clear. SEBI doesn’t recognise these standstill agreements. SEBI says that is a pass-through vehicle. Gains are yours; losses are yours, so why this delay? Had it been in a bank then yes, it is between you and me and whatever it is. I am managing money for 50,000 investors, so I am answerable to them. So yes, SEBI is very right in quashing this and going forward none of this should be considered and whatever your losses are at that day, you take a decision and exit or remain, it is yours and it has to be that way. Mutual funds vehicles are meant that way.

Joshi: This standstill agreement, probably for the first time in 15-20 years, I’ve heard it for the first time. So, was a unique situation where the promoter was very confident that within six months of time, I will make good for the coupon as well as the principle and I will pay and compensate you in terms of interest for the six months extension that you are giving out to me. As Gajendra said, most of the mutual fund managers, CIOs felt that this is in an investor’s best interest. That’s how it came into the picture. What you said also holds true to an extent but that’s not how things shaped up. So, one mutual fund was not party to it, it sold the shareholdings in the open market, right at the beginning. The price took up quite some beating at that point of time. Now, 50 percent of the outstanding has come back to the funds. In that extent, if you just went and sold your shares in the market, your recovery would’ve been much less. So, today investors are in a better position in two counts. One is, 50 percent of the outstanding is back in the schemes so you’re only holding 50 percent more and, on that 50 percent, your collateral stays the same what you had in the beginning in the very first place. So, I would say that it was a once in a blue moon sort of an event. Fund managers gave it their best thought and they acted in a fiduciary capacity. So that capacity, in that duty they have taken that call and now that SEBI has said a firm no, I don’t think its likely to happen anytime, it will just be categorised as default and maybe the segregated portfolio will be the solution henceforth.

Kothari: What it will push ahead is that, all these debt agreements will be far more watertight, I would say. You will go for much higher collateral; you have burnt your fingers.

Joshi: Viewers of this show, I am sure they are not bored. The reason is BFSI or any sort of a sector fund or thematic fund and we have discussed this on show more than couple of times. One, sector fund is a type of a fund in which you enter only when you have a high conviction, it is not for everyone. Two, sector or thematic fund can get, adversely or positively impacted— it cuts both ways by any single factor. It can be a technological innovation. It can be geopolitical factor. It could be any regulation that comes into the picture. You should also be prepared for a high volatility. If you are asking about the recommendations, I will give a scheme recommendation but let me also add that number one and number two. I will say number one and number two because these are the largest AUM funds in the category and largest and second largest funds in this category have four stocks common in top five. So, there is very little differentiation but if I have to choose one then I will go for ICICI Prudential Banking and Financial Services Fund.

Kothari: If I have to go for the fund, it’s the same fund just because of the construct of the portfolio, its mostly geared towards good quality private banks and corporate banks are also there like AXIS and ICICI which can rebound in this current cycle. The reason why I would not like to go for this category fund because in your normal portfolio all existing diversified funds have 30-40 percent exposure to financials. Why create additional?

Kothari: And you need to have very high conviction if you want to go for this category. If you want to take a concentrated bet on banking and financial services, then this fund makes the right bet.

Kothari: I would go for Axis Bluechip Fund, purely from the quality of the portfolio. It’s a highly growth-oriented portfolio, if you see the names out there. The stocks have done well because others could not deliver because they were lagging on the numbers. The fund manager has been performing quite steadily and it’s a very safe portfolio in these times. In the next two years, even when markets look in very turmoil state, this portfolio will be held in good stead.

Joshi: I will also go with Axis Bluechip. The reasons are similar to what Gajendra mentioned. It is a growth-oriented portfolio. Not just that, this fund has consistently beaten the category average as well. So, it does well in the time of volatility that is additional reason if we are talking at this juncture when despite of so many positive announcements have taken place, market is yet to find firm feet on its own. In such scenario if you are wanting to enter large cap then I think Axis is the right fund to choose.

Kothari: Recently, I have invested my money in Axis small cap fund. I just started SIP into this fund, but I also would like to go for ICICI small cap fund since small-cap divergence will be very high compared to large-cap scenario because the portfolios will be completely different. I like small-cap funds because it is managed by Sankaran Naren who has not been very vocal about small-cap fund right now. It’s a good contra bet, they are available at the discount of 30-40 percent. Of course, the economy might take time to rebound but you are accumulating at these good levels, whenever it will rebound it will be sharp V-sort of phase. I still believe that in the next one-two years small caps will do well when the economy will start pumping up.

Kothari: In Axis fund, but I will also recommend ICICI as the size is only Rs 500 crore. In small-cap funds, the moment performance comes up fund flow becomes large and then it becomes difficult for fund manager to replicate the same performance. In that context Rs 500 crore is a good sized fund and there is long runway to go before they can accumulate a lot of money.

Joshi: If you are wanting to invest in small cap let it be via asset allocation route within equity as well. So, if you are holding a 60 percent equity and 40 percent debt sort of a portfolio, within 60 percent of that equity please decide your small-cap allocation. Let it not be your entire or core of the portfolio. It should be at best a peripheral or satellite allocation. Two, accumulate small-cap fund or small-cap fund unit via SIP or STP route. This I think still is not a time to enter into lump sum manner into small cap. Three, my choice of fund here will be ICICI Prudential Fund. The reasons are quite a bit of overlap of what Gajendra has been saying, but smaller size of the fund.