IDFC Asset Management Company (AMC) has announced the launch of an open-ended equity fund, predominantly investing in small cap stocks named IDFC Emerging Businesses Fund. The New Fund Offer (NFO) has opened from Monday, February 3, 2020 to Monday, February 17, 2020, during which, units will be offered at Rs 10 each. The scheme will re-open for ongoing subscription and redemption within five business days from the date of allotment of units at NAV based prices.

Smallcaps have become a flavour of the mutual fund mart on account of hopes of a reversal of the under-performance compared to largecaps. The price correction in smallcaps has resulted in valuations, measured by price/earnings (P/E), becoming cheap compared to the rest of the market. IDFC AMC believes the starting point for any segment of the market to outperform is valuation, either on absolute or relative to its historical / compared with other segments of the market. This is why they are coming out with a smallcap fund offering for experienced investors or those with high risk appetite. The window for investing is narrow as the fund-house wants you to invest through lump sum and STPs of not more than six to nine months. RupeeIQ takes a detailed look.

IDFC AMC

IDFC Asset Management Company Ltd. was established in 2000 and manages an AUM of more than Rs 1 lakh crore for over 1 million investor folios representing leading institutional, family-office and individual clients. Promoted by IDFC Ltd., IDFC AMC is one of India’s top 10 asset managers.

Why now a smallcap fund

While not all the companies in the smallcap space would move up the market cap curve, IDFC AMC believes it is important that we are cognizant of the market phase (pricing/valuation) when we enter into this space.

The three main reasons to consider investing in smallcaps now are based on these factors – Price, Valuation and Volumes.

Smallcaps have witnessed significant price correction since the beginning of January 2018, the underperformance is a whopping 46% vs largecaps, as on December 2019.

Smallcaps are trading well below its average discount with the smallcap P/E at 14.8 versus 5-year average 17.4.

Additionally, smallcap P/E is now trading at a discount of 34% to its largecap counterparts versus average discount of 15%.

Finally, when we compare the volumes in the smallcap segment, a bear market typically witnesses a 65-70% fall in volume from its peak, post which the turnaround begins. The current cycle has already seen volumes fall by 66% from its early 2018 peak.

Fund portfolio construct

IDFC Emerging Businesses Fund seeks to look at growth opportunities in the smallcap space alongside applying quality filters.

Further, the fund is mandated to invest at least 65% in smallcap segment.

IDFC Emerging Businesses Fund will contain buy and hold strategies (buy-and-hold is strategic) as well as opportunistic picks in the cyclical space. The fund will also look to participate in new businesses via IPOs. The fund will be managed by Anoop Bhaskar, Head – Equity, IDFC AMC, who oversees Rs 31,000 crore equity assets at the fund-house.

The smallcap stock selection process with look at both quality and growth.

Quality is identified by cash generation, superior return on capital, and ability to repay debt. Smallcap firms are small companies and hence their financial metrics should not be compared with largecaps. However. between smallcaps, there are varying degrees of financial strength.

Growth will be tracked by medium term growth visibility.

How fund will manage smallcap risks

Smallcap stocks can generate higher returns, as they have higher growth left in them. However, they contain greater risk as well and volatility in performances.

To avoid risks from investing in poor smallcap firms, the IDFC fund will look at qualitative aspects such as feedback on management from suppliers, customers and peers. Further, the scaling up of positions in companies will happen gradually, as a risk mitigation process, in order to reduce the impact of any adverse incidents.

To counter liquidity risk, the fund will have a diversified portfolio approach with a 65-100% exposure in smallcaps and remaining in other equities, depending on market scenario, while also steering clear from a concentrated portfolio (exposure to Top 10 stocks will be <45%).

Are you a smallcap fund investor?

Smallcap investing is typically meant for a seasoned investor or those investors with high-risk appetite. If you are a first-time investor, do not invest in smallcaps. The ideal way for you to begin your MF journey is tax-saving funds (if you claim tax deduction under section 80C), large and midcap funds or multicap funds.

While smallcaps do provide opportunities to generate reasonable outperformance, one needs to be aware of large drawdowns, liquidity issues and governance issues.

To measure your risk-appetite, ask yourself whether you are okay with large, and temporary, losses in smallcap funds of 30-40% in a year. If you are okay, go ahead with smallcap funds.

The fund on its own will aim to have a diversified portfolio approach with a 65-100% exposure in smallcaps and remaining in other equities. The fund will seek to steer clear from a concentrated portfolio – with higher number of shares (>30-35) and lower allocation towards top 10 stocks, as we have mentioned earlier.

A truly diversified portfolio, one that is not concentrated, will also help reduce impact of incidents that may occur due to possible governance issues that are likely in the smallcap space.

Other fund details

For IDFC Emerging Businesses Fund, minimum application amount is Rs 5,000. The fund benchmark is S&P BSE 250 Small Cap TRI, which serves as benchmark for peers like HSBC Small Cap Equity Fund, and Invesco India Smallcap Fund.

The fund will have an exit load of 1% if investment is redeemed/switched out within 1 year from the date of allotment. The exit load is in line with what most smallcap funds offer.

RupeeIQ take

While there is no surety of no downside in any investment, at current valuation, chances of a sharp downside appears limited in smallcaps.

IDFC Emerging Businesses Fund wants you to approach the current smallcap investment opportunity with lump sum and STPs of not more than 6 to 9 months. Equally weighted SIPs of three to five years would come in too late to catch the favourable cycle.

The ideal investment tenure for investors in this segment would be more than five years.

Kumar Shankar Roy

Kumar Shankar Roy is contributing editor with RupeeIQ. Kumar is a financial journalist, with a functional experience of 15 years. He tracks mutual funds, insurance, pension, PMS, fixed income/debt and alternative investments markets closely. He has worked for The Times of India, The Hindu Business Line, Deccan Chronicle Group, DNA, and Value Research, among others, across different cities in India. He is deeply interested in marrying data insights with actionable opinion. He can be contacted at [email protected].

View all posts