Small-cap, arbitrage funds buck 'low inflow' trend this calendar

Small-cap funds benefit from better valuations and performance track record, say analysts

Two equity funds at the opposite ends of the risk matrix — small-cap and arbitrage — bucked the ‘low inflow’ trend in May this calendar year 2023 (CY23) to receive the highest net inflows in recent years.

The Rs 3,280-crore net inflows into small-cap schemes in May was the highest for the category since the mutual fund (MF) industry started releasing fund-wise inflow data in April 2019.

Arbitrage schemes raked in a net Rs 6,640 crore — the highest since July 2021.

The inflows into small-cap schemes have been on a steady rise the past six months mostly due to a perception that the small-cap segment is better valued, observe experts.

“Investors are seeing value in the small-cap space after a substantial drawdown in prices during the correction phase. They want to participate in the upward momentum through MFs,” says N S Venkatesh, chief executive officer, Association of Mutual Funds in India, while releasing the latest MF inflow data on Friday.

“Investors come into small-cap funds with a long-term perspective. Inflows mostly come through systematic investment plans. These schemes have done well in the recent past and are seeing continued traction. The number of investors has also gone up. Since valuations are much lower than the peaks, even value-conscious investors are coming in,” says Saugata Chatterjee, chief business officer, Nippon India MF.

In the past six months (December 2022 through May 2023), small-cap funds have drawn net inflows of Rs 14,640 crore. By comparison, the two most popular equity MF offerings — large-cap funds and flexi-cap funds — have received just Rs 645 crore and Rs 4,500 crore, respectively.

The National Stock Exchange Nifty Smallcap 100 Index went through a steep correction in the first three months of CY23, with the index trading 28 per cent below the all-time-high levels at the end of March at 8,982. It has since recovered to 10,533 and is only 13 per cent below the all-time high.

“The valuation difference, juxtaposed with large-cap stocks, continues to play out well for investors preferring mid- and small-cap funds since the beginning of CY23. On a year-to-date basis, the Nifty Midcap (9 per cent) and the Nifty Smallcap (8.3 per cent) have delivered better returns than the Nifty50 (2.74 per cent) or the Nifty Junior (1.62 per cent),” says Gopal Kavalireddi, vice-president-research, FYERS.

Arbitrage funds — the least risky of equity funds — have gained traction in the first two months of the current financial year (2023-24) as they emerge as an alternative to debt funds after a change in taxation rule. In the past two months, investors have discharged a net Rs 10,360 crore into these schemes.

These funds, which fall under the hybrid MF category, generate returns by using the strategy of simultaneously buying and selling the same underlying security or its derivatives in different market segments to make risk-free profits.

The surge in investor interest in arbitrage funds is also a result of their improved performance.

According to Value Research data, arbitrage funds have delivered their best performance in the previous quarter at least since April-June 2020.

Between January and March this calendar year, these schemes have delivered average returns of 1.84 per cent. The one-year return (as on June 11) stood at 6.19 per cent.

Given that equity schemes have become more tax-efficient than debt schemes after a change in taxation structure, wealthy investors and corporations are looking at arbitrage funds for their fixed-income allocation.

Gains from debt funds are taxed at the investor slab rate, while profits from equity schemes are taxed at 10 per cent if the units are held for more than a year. Gains of up to Rs 1 lakh are exempt from tax. 

 SMALL IS BIG

• The Rs 3,280-crore net inflows into small-cap schemes in May was the highest for the category since the mutual fund industry started releasing fund-wise inflow data in April 2019
• Arbitrage schemes raked in a net Rs 6,640 crore — the highest since July 2021
• Investors are seeing value in the small-cap space after a substantial drawdown in prices during the correction phase