Placing Small Bets

Small-cap funds help spread risk, yet make gains.

If you had invested Rs 1 lakh in Crompton Greaves on 1 January 2002, your money would have grown to Rs 65 lakh by now. Back then, Crompton Greaves was a small capital goods company with a market capitalisation, or market cap, of Rs 115 crore and a stock price of Rs 1.80.

It has been one of the biggest wealth creators in the Indian stock market and given 52 per cent annualised return over the last 10 years. The company had a market cap of Rs 8,300 crore on 28 November 2011 while its stock was trading at Rs 123.

On 2 January 2002, Sesa Goa had a market cap of Rs 99 crore and its stock was at Rs 1.28. On 28 November 2011, the stock was trading at Rs 174 and the company's market cap was Rs 16,000 crore.

Scores of once small companies have over the years grown big, giving investors a 30-50 per cent annual return over 10-15 years and creating fortunes for investors. However, more often than not, we find ourselves at the wrong side of the fence and regret our inability to spot such stocks on time.

The number of small-cap stocks is large and finding a quality stock that can give high returns over a long period is tough even for equity analysts. One reason is that such stocks usually have a short history and are not tracked by many analysts and brokerage houses. Then there are risks such as low liquidity, governance concerns and competition from larger players.

If these factors scare you but you still want to gain from the upside potential of such stocks, small-cap mutual fund schemes are an ideal choice for you.

A typical small-cap fund invests over 50 per cent money in stocks of small companies. However, the fund manager can lower the exposure depending on market conditions. Mid-cap stocks form 25-35 per cent of the portfolio. A small portion, usually less than 10 per cent, is invested in large-cap stocks. Mutual fund schemes that invest a large part of their money in small-cap stocks also carry a higher risk.

RISK-RETURN TRADEOFF
It's a challenge for the fund manager to build a portfolio of quality small-cap stocks as the number of such companies listed on exchanges is huge. Also, many of them are little-known.

"The number of small companies listed on Indian stock exchanges may run into a few hundred. Out of this, 30-50 companies can be selected for investment. The challenge is that many of them may be under-researched by research/brokerage houses. One may have to rely extensively on primary research," says Dhiraj Sachdev, senior vice president and fund manager, equities, HSBC Asset Management India.

Another risk is low volumes, which makes these stocks illiquid. This means the fund manager may not be able to sell the shares as and when he wants. Small-cap funds are thus prone to liquidity risk. For example, the average number of daily traded shares in the CNX Small Cap index was 75 million compared to CNX Nifty's 141 million during the year ended 30 November 2011. CNX Nifty comprises large-cap stocks. Anyone investing in small-cap funds, therefore, should have a long investment horizon.

Small-cap companies see sudden rise and fall in stock prices and this is reflected in the net asset values, or NAVs, of funds investing in such stocks. "Due to small size, such companies are more prone to volatility," says Vinay Paharia, fund manager, Religare Mutual Fund. Paharia manages Religare Mid and Small Cap Fund.

Therefore, only investors with appetite for high risk should go for such funds. Besides, small-cap funds should form a small part of your portfolio.

Mutual funds investing in small-cap stocks can minimise the risk by diversifying across companies and sectors. Since mutual funds are managed by professional managers supported by teams of analysts and researchers, they are in a better position to select the right stocks, diversify across sectors and companies and react swiftly to changes in equity market conditions.

HOW THEY PERFORMED
There are four mutual fund schemes-Sundaram Select Small Cap, Reliance Small Cap, HSBC Small Cap and DSPBR Micro-Cap-which invest primarily (50 per cent or above) in small-cap stocks. None of them have a track record of five or more years. Only Sundaram Select Small Cap and HSBC Small Cap have completed three years.

In the one-year period up to 9 January 2012, the NAV of these funds fell 25 per cent on an average compared to the 38 per cent drop in the BSE Small Cap index. HSBC Small Cap fund fared the worst as its NAV dropped 42 per cent.

Sundaram Select Small Cap was the best performer with a return of -16 per cent. Sundaram Select Small Cap is a close-ended fund and its units are on offer for a limited period. Mid- and small-cap funds performed slightly better on the downside with an average -19 per cent return in the one-year period compared to the -29 per cent return delivered by the BSE Mid Cap index.

The average three-year return by small-cap funds as on 9 January 2012 was 25.5 per cent compared to 24 per cent by mid- and small-cap funds. The average return of large-cap funds in the past one year has been -19 per cent. The average three-year return by large-cap funds was 17.518 per cent on 9 January 2012.

ARE YOU GAME?
Those who wish to invest in small-cap funds should do so only if they have a long investment horizon and tolerance for volatility. Small-cap stocks suffer the steepest falls in a bear market and rise the most in a bull market. An investor should stay put for at least three-five years to allow the fund to gain from at least one bull run.

A small-cap fund will generally witness more frequent changes in its portfolio than a large-cap fund. It's better to go for schemes with a low turnover ratio, which measures how much the portfolio has been churned. A higher ratio means a higher trading cost.

Buy funds with lower volatility, which is measured by standard deviation (SD) and beta. The higher the SD and the beta, the more volatile the fund is. A better way to judge the performance of the fund is to check its Sharpe Ratio, which measures the risk-adjusted return. The higher the Sharpe Ratio, the better is the fund's performance. R-squared is the proportion of the fund's portfolio that moves in line with the benchmark index.

You can check these ratios in fund factsheets released by fund houses every month. These factsheets are also available on websites of mutual funds.

"Small-cap funds are good only for a portion of the portfolio. These funds are more volatile than large-cap funds. While there could be a possibility of higher returns from these funds, I think only a small percentage of wealth should be invested in such funds," says Raghvendra Nath, managing director, Ladder up Wealth Management.

There are many companies in the small-cap space that may become success stories in the future. Investing a small portion of your savings in the small-cap theme through mutual funds may give you a pleasant surprise.

Source: http://businesstoday.intoday.in/story/invest-small-cap-mutual-funds-companies-good-returns/1/21880.html

India corporate bond yields steady, liquidity stays tight

Indian corporate bond yields closed little changed on Monday, with investors preferring to stay on the sidelines as liquidity in the banking system remained tight.

The five-year benchmark corporate bond yield ended unchanged at 9.44 percent, while the 10-year bond closed 2 basis points lower at 9.30 percent.

Indian corporate credit issuance is expected to gradually recover this week after the central bank desisted from signaling any near term cut in policy rates, dousing hopes that borrowing costs will decline soon.

National Bank for Agriculture and Rural Development (NABARD) plans to raise 7 billion rupees through three-year bonds at 9.48 percent, three sources with direct knowledge of the deal said on Monday.

But traders said that issuance was slow because of tight liquidity conditions.

"A lot of issuers are waiting for better liquidity conditions to hit the market, especially in the private sector," a senior dealer with a mutual fund said.

Indian Railway Finance Corp (IRFC) received first-day bids for more than seven times the base amount offered in its sale of retail bonds, signaling continuing appetite for debt from state-own firms despite lower returns.

IRFC is looking to raise atleast 30 billion rupees via a 10- and 15-year tax-free public bond issue, which has a green shoe of 33 billion rupees.

The spread between the 10-year corporate bonds and government debt of the same maturity widened to 81.24 basis points from 77.26 basis points on Friday.

Total volume in the corporate bond market was 20.97 billion rupees, higher than Friday's 10.30 billion rupees.

Source: http://www.reuters.com/article/2012/01/30/india-markets-corpbonds-idUSL4E8CU4TY20120130

CPs, CDs may get to trade on bourses

The Securities and Exchange Board of India (Sebi) is planning to allow certificates of deposit (CDs) and commercial paper (CP) with residual maturities of 60 days or less on the exchange platform.

This step is seen as a precursor to the mark to market (MTM, revaluing assets at current worth) requirements for mutual funds (MFs), to be implemented from Day 1. Last week, Sebi brought down the threshold for MTM of debt securities by MFs to 60 days from 91 days.

“Sebi wants to take it to Day 1. At present, it is difficult to draw yield curve maturities below 60 days. In the normal course, the short-term yield curve has to be upward sloping. But, since prices are not transparent, we have a flat yield curve,” said a person familiar with the development.

A CD is a time deposit with a bank. CDs are generally issued by commercial banks and can be bought through brokerages. They bear a specific maturity date, a specified interest rate and can be issued in any denomination, much like bonds.

CP is a short-term debt instrument issued by companies. These, typically, bear coupons marginally higher than that of CDs. At present, in the absence of transparent pricing in the over-the-counter (OTC) market, it is difficult to decipher a fool proof valuation mechanism for these instruments. “If it’s on an exchange platform, prices can be seen by everyone and it will be easier to draw a curve,” the person added.

At present, these instruments are traded privately but the trades are reported on the exchanges. Devendra Nevgi, founder, Delta Global Partner, said the move would be good in the long term. “Post-trading reporting is of no great use. If the instruments are actually traded and reported on a real-time basis, it will be of great value. This mechanism will make the Net Asset Values(NAV) more realisable. Investors can be sure the NAV they see is what they get, both while purchasing and redeeming.”

Nevgi says it is important to build the peripheral infrastructure to make the exchange mechanism successful.

“Otherwise, what happened in the case of fixed maturity plans (FMPs) will be repeated here. The exit will only be on paper ,” he adds.

Sebi had made listing of FMPs compulsory to allow exits to small investors. However, due to lack of liquidity, meaningful exits are not possible in most cases. Comprehensive changes need to be made in the Companies Act, RBI rules and other relevant provisions to make this effective, said a fund manager. “Once listed, issuers should also be allowed to buy back, if necessary,” he added.

Also, typically when debt instruments are traded, the volume is concentrated in better rated instruments; lower rated ones don’t get traded. On the flip side, listing may increase the cost for issuers, experts said.

Source: http://www.business-standard.com/india/news/cps-cds-may-get-to-tradebourses/463254/

Fidelity in talks to sell India mutual fund business-report

• Fidelity seeking a valuation of $202 million - report
• Large number of MFs including Goldman Sachs unit likely to bid
• Fidelity managed assets worth $1.8 billion as of end-Dec

Fidelity Investments is in talks to sell its India mutual fund business and is seeking a valuation of 10 billion rupees ($202 million) for the unit, a report on the Economic Times website said citing a person with direct knowledge of the development.

Fidelity's India fund management arm, which was launched in 2004, may attract interest from a large number of fund houses including Goldman Sachs' asset management unit, said the report.

Advisors representing Fidelity circulated a "request for proposal" to companies interested in buying the asset last week, it said.

The fund manager may retain a small team in India that will advise investors on its India-focused offshore funds, the report said.

A spokesman for Fidelity's asset management arm in India did not immediately respond to a mail from Reuters seeking comment.

Fidelity managed assets worth about 88 billion rupees ($1.8 billion) as of end-December 2011, according to data from the Association of Mutual Funds in India, making it the 15th largest company in India's competitive asset management business.

The company's average assets under management has slightly fallen from 91 billion rupees at the beginning of the last year, the data showed, with India's main market index posting a drop of nearly 25 percent in 2011.

Assets managed by fund managers in India rose to 5.9 trillion rupees ($119 billion) as of March 2011 from 2.3 trillion in March 2006, according to a study by research and consultancy company PricewaterhouseCoopers.

Lured by the long-term prospects of Asia's third-largest economy, overseas fund managers, such as U.S.-based T. Rowe Price Group Inc and Fidelity, have been buying into Indian money managers or setting up operations on their own.

Nippon Life Insurance earlier this month agreed to pay $290 million for a 26 percent stake in the asset management unit of Indian financial services provider Reliance Capital Ltd .

Wall Street bank Goldman Sachs last year bought India's Benchmark Asset Management Co, which managed about $700 million in assets at that time.

However, the sharp fall in the equity markets and the recent regulatory changes such as the removal of the entry load, or a commission charged by a mutual fund distributor for selling a product, has added to the competitive pressure in the sector.

Source: http://www.reuters.com/article/2012/01/30/fidelity-india-idUSL4E8CU45V20120130

Invest in various types of debt since you can't take the rate movement for granted: Debasish Mallick, CEO & MD, IDBI AMC

The strategy that investors should adopt at the current juncture, the IDBI Mutual Fund's plans for market penetration and the future of the fund industry are some of the issues that Debasish Mallick discusses with ET.

When can we expect the market sentiment to improve?
The debt overhang in the western countries is likely to continue for a long time. If it does, it will have a major negative impact on the global market sentiment and sentiment will decide the course of the markets. FII investments are also not likely to go up in India any time soon, especially with uncertainty about the domestic economy and doubts over the reforms programme. Other emerging countries are also likely to give better returns. On the domestic front, inflation has started to ease a bit, though there are concerns that it is temporary and may go up again. Core inflation will have to correct in some time. This is the lag effect of all the 13 rate hikes that we were so critical about. After a clear view emerges on inflation, the RBI is likely to tinker with the rates. I don't expect an interest rate cut soon and we may have to wait for some more time. When it happens, it will improve the market sentiment, even though volatility will be the order of the day.

How will the earnings season pan out for India Inc?
It's good that the domestic market is large because, for the Indian corporates, it means lesser dependence on the overseas market. However, over the past four months, inflation has increased the cost substantially. While raw material costs have gone up, the markets for these products have not been vibrant. People have deferred major purchases over the past quarter. This may be reflected in the current earnings season. The margins for the Indian companies are not likely to be healthy in this quarter.

What strategy should the investors adopt?
At all times, the investor should maintain a prudent asset allocation with a mix of debt, equity and gold. The extent of allocation in these asset classes should depend on individual needs. At the current juncture, it would be wiser to be invested more in debt than in equity. Within debt, one should have a variety of products as rate movement should not be taken for granted. At the same time, equity should not be written off for one could take a call on these after some time.

Which particular products would you recommend to investors now?
Investors could consider the IDBI Mutual Fund's Regular Cash Flow Plan under its MIP scheme. One could start a SIP under the growth scheme for a period of five years, or put in a lump-sum investment. On completing at least five years of continuous investment or accumulating at least `5 lakh under the scheme, you can switch over to the dividend option, which will give you returns for life. It acts as a second income or cash flow for life. This product is targeted at the retail investor and is available at all IDBI Bank branches. In the past year or so, since the launch of this scheme, we have been one of the few fund houses that has paid a regular dividend.

The fund industry has lost out in the past 2-3 years. How can it be revived?

There are two sides to this story-AUMs and number of folios. Ideally, one should be connected to the other, but this is not always the case. A large part of the AUMs has shrunk primarily because corporates have found better avenues to invest in. Perhaps, when the rates become more favourable, corporate money will start flowing back into the industry. This will be a cyclic process-at times mutual funds will attract more money, and at other times, banks will garner more attention. We have to work towards minimising the damage, that is, look for ways to ensure that the product remains buoyant at all times. The other more fundamental and permanent problem is the RBI regulation restricting bank investments in the fund industry. We'll have to learn to live in a situation where bank money will be less important in the system.

Coming to the decline in folios, it is essentially a retail story. Retail investors always come into the picture when the industry is offering good returns. Right now, the sentiment is negative. This is again a cyclical phenomenon. There is no doubt that lack of interest is a cause for concern. A mutual fund company cannot sustain itself unless it has a good retail base because that is the only stable money. So retail money in both equity and debt segments is very important. Then again, it has more to do with the market sentiment at any given point of time. What we can ensure is products for all seasons. Once we have a sufficiently wide product base, along with a good distribution network, then retail money may be more sustainable.

What are the emerging trends for the mutual fund industry?

The next phase of growth will be centred on the retail segment and market penetration. The competition in this space is very intense. Also, the divisions between financial services entities are becoming increasingly blurred. For instance, there is an overlap of products across banking and insurance. So the competition between fund houses may also come from players in other segments. Regulation will also start getting blurred and could lead to a more level playing field, resulting in fiercer competition. This could lead to an increased product penetration.

Your fund house derives strength from IDBI Bank's branch network and reach. How else do you plan to penetrate the market given the lack of distributor interest?

Our main strength is indeed the IDBI Bank platform with around 950 branches, of which 650 are distributing our products. We also have about 3,500 IFAs empanelled with us and, of late, our product pick-up has increased from this segment. Besides, we have tied up with six major banks to sell our products and, in the future, we will consider smaller banks as well. We are now at a stage where we are gaining credence in the market and have a strong brand name. As regards the distributors, we believe presenting the right product at the right time to the distributor is more important than monetary incentivisation. So we are not giving incentives that are out of sync with the industry practice as it will not help us penetrate the market on a sustainable basis. We are trying to focus on the relationship, product, performance and network.

Source: http://economictimes.indiatimes.com/opinion/interviews/invest-in-various-types-of-debt-since-you-cant-take-the-rate-movement-for-granted-debasish-mallick-ceo-md-idbi-amc/articleshow/11664232.cms?curpg=2