Is this the right time to invest in the small-cap segment?


Edelweiss Mutual Fund is launching a new fund offer (NFO) of a small-cap fund, the Edelweiss Small Cap Fund, with an added feature called Smart Trigger-enabled Plan (STeP). As the name suggests, the fund will invest in the small-cap segment of the market and the STeP facility will enable investors to stagger their investments into the market over a period of time as a way to deal with volatility and to reduce timing risks.

What is it?

The Edelweiss Small Cap fund will invest at least 65% of the corpus in small-cap companies. These are companies that when ranked on the basis of full market capitalisation fall below the 250th rank. The fund can also take exposure of up to 35% in large- and mid-cap stocks or debt and money market instruments.

The STeP facility will help invest on market declines. The investment will go into the fund in five instalments. The first 20% of the application amount will be invested upfront into the small-cap fund. The remaining 80% will be invested in Edelweiss liquid fund. The trigger for each monthly transfer from the liquid fund to the small-cap fund will be a 3% decline in the small-cap index from the date of allotment. If the trigger is not hit, then the allotment will be done on the last business day of the month. The number of transfers will be limited to one a month even if the index falls by more than 3%. The idea is to capture a fall in the index, if any, in the election months of May and June 2019.

Investors can choose to transfer any portion of the balance from the liquid to the small-cap fund at any point. They can also invest a lump sum in the NFO and the entire money will be invested at one shot in the small-cap fund on the day of the allotment Or, they can invest through a regular SIP. However, in this option, they won’t have the benefit of the trigger to make investments into the small-cap fund when market declines.

What is good?

Unlike the past, where fund houses have rushed in with NFOsto take advantage of a run-up in the market or a segment, this time we are seeing a slew of small-cap funds when the segment has seen steep correction. The Nifty Small Cap 100 index fell by 29% in 2018 and this NFO seeks to benefit from better valuations and investment opportunities created by the correction. The small-cap fund category reflects volatility. One-year return in the category has been -21.71% and the 3-, 5- and 10-year returns have been 10.92%, 21.38% and 20.47%, respectively.

The fund intends to follow stringent sector and stock selection process to identify good quality companies with strong businesses and return ratios. “We classify stocks in four buckets—strategic, tactical, defensive and options—based on their characteristics and the role we expect them to play in the portfolio,” said Radhika Gupta, CEO, Edelweiss Asset Management (see graph).

Mint Money take

While the small-cap segment has seen substantial correction, not all stocks in the space, particularly the strong companies, can be considered attractively priced yet. The segment has the potential to outperform large-caps and mid-caps but it also sees the deepest cuts when economic and market conditions turn unfavourable. In an election year, fiscal prudence is likely to take a backseat and this, along with the possibility of an election outcome that may not be in the best interest of the economy, will have consequences for the markets.

Sebi’s recategorisation of MF schemes shrunk the investment universe for large- and mid-cap funds, leaving an unattended large catchment area for small-cap funds. While the valuation argument post the 2018 correction is compelling, small-cap funds are not for everyone. The extreme volatility in returns, which is a distinct possibility in the run-up to the election and beyond, may be unnerving for investors not used to it.

If your asset allocation and risk tolerance allow it, then consider investing in the NFO. The STeP facility refines the SIP to enable investors to benefit from any correction in prices of stocks more effectively. Stock and sector selection will be important parameters and the fund house has seen some success in building large- and mid-cap portfolios.

“This fund is trying to normalise volatility through the systematic transfer route but unless you are willing to leave your investment for 3 years, this fund is not for you. Small-cap funds are high-risk, high-reward products but the returns can go down quite a bit before they go up,” said Shyam Sekhar, chief ideator and founder, Ithought. Investors must be willing to ride the volatility and give the investment adequate time for portfolio selections to play out.