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.
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.
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.
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.
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.
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
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