Braving the rapids: Smallcap funds ride the risky tide with spread bets

RIDING THE WAVE: Smallcap stocks dominate portfolios in the year's rally

The number of stocks held in smallcap fund portfolios has shot up in the past year as fund managers sought to spread their bets amid escalating valuations and a jump in inflows. The top five smallcap schemes now hold an average of 105 stocks, compared to 89 at the end of January 2023, according to an analysis of their portfolios.

The Nippon India Small Cap Fund, the largest in the category with assets under management (AUM) exceeding Rs 45,000 crore, is currently invested in nearly 205 companies. A year ago, the tally stood at 167. Consequently, the average allocation to each stock has decreased, even as its AUM has nearly doubled in the past year. In the case of the Axis Small Cap Fund, the number of stocks has increased by nearly 20 in the past year. As of January 2024, it was invested in almost 100 stocks.

“The number of sectors and companies that have shown improvement in earnings has increased over the past few years. Accordingly, the number of stocks is higher. Exposure to largecap has also increased, on a relative risk/reward basis compared to midcaps and smallcaps,” said Shreyash Devalkar, head of equity at Axis Mutual Fund (MF). With the valuations of most smallcap stocks soaring above long-term averages, fund houses have been taking measures to lower the risk in their portfolios. These include raising the cash level, allocating a larger share of the corpus to largecap and midcap stocks, and even imposing restrictions on the amount investors can contribute every month.

 

The Nifty Smallcap 100 is up 66 per cent in the past year. The index’s price-to-earnings ratio has swelled to 20.8x vis-à-vis the five-year average of 17.1x. In a letter to the Association of Mutual Funds in India last week, the regulator called for an investor 

protection framework, specifically for smallcap and midcap fund investors. MFs have also been asked to enhance disclosures. They will now be sharing stress test reports of smallcap and midcap schemes every 15 days.
 

The smallcap indices have seen some correction this week, and experts see these indices underperforming the Nifty50, mostly due to the valuation differential. “This trend is likely to continue since valuation in the broader market remains highly elevated, and the regulator has sent a clear message regarding the froth in the segment. investors have time to switch from smallcaps to fairly valued largecaps and partly to fixed-income products,” said V K Vijayakumar, chief investment strategist at Geojit Financial Services.