Many stock market pundits have been predicting the revival of small and mid-cap segments for a while before the pandemic made such predictions futile. Do you see a revival of the small cap segment anytime soon?
You are right, just before pandemic started, there were signals that economy is bouncing back after years of subpar growth. In addition, the small cap segment had already been in bear market for more than two years (since Jan 2018). Small cap Index at that time was underperforming large cap index by huge margin, so risk-reward was in favour of small cap and we were indeed expecting this space to do well.
But then suddenly pandemic and lockdown happened creating all round panic in the market. In this fall, small cap segment was one of the worst hits. There was massive erosion in values. However, that fall also provided very attractive entry point for long term investors. (This is the time when we opened our fund for lump sum subscription).
At that time the general belief was large caps would recover first and small caps would take time to recover. However, the pace of recovery and size of recovery in small cap space since then, has surprised many market participants.
There are many reasons for this recovery. One, valuation during panic had become mouth-watering. Second, the quality of companies which are there in this space are now much better. These are the companies which have survived one of the toughest periods for Indian economy post demonetization, GST, debt crises etc and hence of much strong breed. Third, many of these small cap companies are now managed by young professionals who are hungry for growth who understand the importance of market cap, whose approach to business is much more contemporary. Fourth, there are many businesses which are likely to benefit due to change in global supply chains such as chemicals, pharma, India manufacturing theme (electronics manufacturing, defence etc), technology, data etc. Fifth, as mentioned earlier, small cap bear market was more than 24 months old and hence there was already good time correction. Six, high level of liquidity and retail participation.
Small cap mutual fund investors have suffered negative returns in the 2018 and 2019. Can they hope for a better deal in the next year? The virus pandemic seems to have spoiled 2020.
After long five years of bull run, small caps were at peak in early 2018. Small caps have been in bear markets since then. Therefore, those who invested in 2018 and 2019, got the timing wrong and weak economy also did not help.
The real beauty of small cap investing is felt during a bull market. It is very important, therefore, that investors uses the bear markets to their advantage and come with a long-term outlook and has the mindset to withstand interim volatility and have patience to hold till bull market comes. We feel Indian economy would bounce back well post covid. What we like is that entire focus of government both centre and states is now on turning around economy which is very good. 2020 post march has been very good for small cap space, and we feel those who will have patience would get adequately rewarded.
Nippon India Small Cap Fund has managed to contain the downside in both 2018 and 2019 well. Do you place extra emphasis on downside protection due to the extreme volatility in the small cap segment?
We have adequate risk management practices which take care of stock specific risk, sector risk, liquidity risk etc . The kind of environment we were in for the last few years, we do were extra cautious in terms of not taking large exposure to high risk high debt companies.
Nippon India Small Cap Fund has over 100 stocks in its portfolio. Is this an attempt to make the scheme resilient to likely shocks, typically associated with small cap stocks?
The diversified portfolio is due to liquidity constraints in this space and it also helps in risk management. But having said that, we do ensure that top 50 stocks of the portfolio account for 70-75% of AUM thus longer tail don’t hurt us. Also, we have very large research team to track these stocks closely, so we don’t see issues in monitoring them closely. Our approach is how using our research capability we create a bouquet of 90 to 100 India’s best companies in this space. We are well diversified across stocks, sectors and investment styles.
Most investment experts believe it is not wise to invest in small cap schemes because of the extra risk and volatility associated with them. They argue that an extra return of 2-3% is not worth the extra pain. What is your view?
After so many years of slower growth in economy, one of the wort bear markets for small cap since Jan 2018, that kind of feeling is natural. But we do not agree with that view at all. Small cap companies account for roughly 15% of overall market cap of India. Our view is that small cap should be atleast 15% of one’s equity allocation, if not more.
Small cap is a space where we get tomorrow’s mid-caps and large caps. This is a space where we get new emerging sectors and businesses. This is a space where one can find real high growth companies. This is a space where one finds multi-baggers. No investor can afford to ignore this space.
In addition, our view is that Indian economy is on the cusp of multi-decade growth and there would be many opportunities in this space. In fact, our view is that this is time to focus more on this space.
Many new investors who have got into these schemes after the demonetisation are feeling the pinch now. Do you think new investors should invest in small cap schemes?
All the investors who have felt pinch over last few years due to one of the worst small cap bear market, would start seeing benefits of their patience in years to come. This is a space where one has to come with at least five to seven-year outlook. Chances of investor coming with that kind of investment horizon not making money are very low. Investors should have the patience to wait till a bull market. A bull market completely transforms this space. SIP is another good way of investing in this space.