Have you ever thought about who makes a profit when you buy a car? There are no prizes for guessing; it is the car manufacturing company. However, this answer is partially true. It is not only the car manufacturer but also many other allied companies, such as battery producers, automotive parts manufacturers, and vendors who supply vehicle components, that are the beneficiary of auto sales. The same is the case when you buy a house. Many of them are unknown names. These are small companies with high growth potential. The number here is extensive, and most of them are under-researched, and finding gems among them is difficult for an ordinary investor. In this scenario, small-cap funds come handy to exploit the growth potential of small companies.
Why Invest In Small Cap?
The newly launched MMSCF scheme will focus on creating a diversified portfolio of companies from the small-cap space with a long-term perspective. According to the fund house, the scheme "will invest a minimum of 65 per cent of net assets in equity and equity-related instruments of small-cap companies. The scheme may also take exposure in equity derivative instruments up to 50 per cent of the equity permitted component. Investment in derivatives shall be for hedging and portfolio balancing." The fund will be managed by Abhinav Khandelwal and Manish Lodha.
Small-cap mutual funds have the potential to create wealth and generate alpha over the long term, as they provide exposure to companies that are potential market leaders in the industries they operate in and are likely to become future midcaps as they scale up. In addition, they are generally under-researched and under-owned, thus providing an opportunity for stock picking at reasonable valuations.
Despite all headwinds, India has outperformed its global peers. "The Indian economy is well poised and has the potential to be one of the leading economies in the world over the coming decade. This may throw unprecedented opportunities across sectors and businesses, with many smaller companies using this possibility to become much larger over time. Small-cap funds would be an ideal option for long-term investors looking to take advantage of this change and should become a core part of investor portfolios," says Anthony Heredia, MD & CEO of Mahindra Manulife Mutual Fund.
According to the Association of Mutual Funds in India (AMFI) classification, stocks beyond the first 250 stocks fall under the small-cap category. "Indian small caps offer a wide range of companies that are likely to participate and grow with the Indian economy as India moves from 7th largest to 3rd largest economy in terms of size. The economy offers opportunities for many small-cap companies to grow to be mid-cap companies in the future," says Krishna Sanghavi, the chief investment officer of equity, Mahindra Manulife Mutual Fund. If you look at the long-term performance of the small-cap funds, they have outperformed their large-cap counterparts by a huge margin. However, in the last one year, small-cap indices are lagging. Given this, it offers an opportunity for a better valuation. "Valuation-wise, small caps currently offer a good opportunity for investors who want to build a long-term equity portfolio," adds Sanghavi."
Should You invest?
The key to successful investing is diversification. If you have adequately invested in large-cap and mid-cap funds, you may add some exposure in small-cap funds if you are willing to take higher risks. Historical data shows years where small caps have lagged, are followed by years of superior returns. Considering small caps have corrected meaningfully in 2022, it is an excellent time to utilise this opportunity.
Given the large universe of small-cap and being under-researched, the stock-picking acumen of fund managers plays a crucial role. Past track record and the process-driven approach of the fund house, chief investment officer, and fund managers give comfort. MMSCF is one of the options investors may like to look at.
