Opportunities & Challenges in the Small Cap Space: Interview with Chirag Mehta, CIO & Fund Manager

The Small Cap universe is very vast and has showcased good growth potential. After the recent runup in Small Cap Indices, we are now seeing a consolidation. Will the markets correct further? Are the valuations favourable? Which are the sectors or themes that will show prospects for growth?

Join Chirag Mehta, CIO & Fund Manager, as he shares answers to these questions and other insights as to how Quantum’s New Fund Offering (NFO) is set to make a big difference to investor portfolio.

1. What is your outlook for Indian equities from a medium to long term (3 to 5 years plus) perspective?

Though markets (Sensex TRI) have corrected by approx 4% over the last month, the long-term story looks robust. India is standing out amidst the global uncertainties. Bulk of the high frequency indicators indicate positive momentum be it PMI (Purchasing Managers Index), GST collections, E-way bills and credit growth. Weak recovery in China is also helping the relative preference for India.

Corporate earnings cycle and macro environment continues to be conducive for a broad-based growth. The economy continues to benefit from fundamentally stronger balance sheet positions of the private sector and the government’s supply-side focused policy measures reinvigorating capex.

While relative valuations remain rich, India is in a comfortable spot due to the economic upcycle it finds itself in and strong earnings growth prospects. As such, we are bullish on Indian equities in the medium to long term.

2. Small caps have seen a correction after a great rally this year. What are your views on valuations at current price levels?

Small cap indices and some small cap stocks are trading close to long term averages currently, However, there are pockets of value and several bottom-up stories which are not driven purely by the macroeconomic environment and would still be available at prices below the fair value. Through our research, we are confident of building a robust portfolio of 25-60 stocks at reasonable prices to translate into an upside for the portfolio.

3. Are there attractive investment opportunities from a long-term investment horizon perspective? In which sectors you see good earnings growth potential in the medium to long term?

As Small Cap universe is large and much diversified as compared to large cap universe we see many attractive investment opportunities at these prices from a long-term investment horizon perspective. Themes like Financial inclusion, transition to EVs, Import substitution, China+1, Renewable Energy are themes which we feel have good earnings potential in the medium to long term.

4. What are the things investors should keep in mind when investing in small cap funds?

From many options in Small Cap Funds, you need to be cautious to invest in the right Small Cap Fund that can face challenges such as:

Risk of outsized positions: Some Funds with large AUM can face liquidity issues if they end up owning a big part of a small cap stock’s market capitalization. Low liquidity leads to risks of higher impact cost on exit.

Overdiversification: They may be compelled to have a long tail of stocks with suboptimal weights. When a Small Cap Fund portfolio consists of holdings with weights below 1%, it indicates excessive diversification or overdiversification. In such a scenario, any positive performance in an individual stock may not significantly contribute to the overall returns of the Fund.

Deviation from fund mandate: They may be forced to either sit on cash or to invest incremental inflows into mid or large cap names, which is not what a small cap fund’s objective is.

So, if your investors are starting to invest in the small cap space or want to invest further into this sector, consider a small cap fund which is disciplined about its fund capacity and prioritizes fund performance and liquidity over gathering more Aum.

Equally important is evaluating the integrity and quality of the management teams within smaller companies, as these firms may encounter governance challenges due to their limited financial resources, making it difficult to attract top-tier management talent. Additionally, they might face less scrutiny from external parties. This is where Quantum Small Cap Fund can make a big difference. Our commitment to integrity dates back to 1991 at the Quantum group level. We prioritize safeguarding your investments over chasing short-term gains and prefer to avoid opportunities that could compromise your investment, even if a particular stock carries significant weight in the benchmark index.

5. What are the salient features of this fund?

Backed by our strong research capabilities, we are set to help investors navigate the large (+950 stocks universe) small cap universe. Our experience of assessing governance and management quality will add value as smaller companies may not attract the best management talent and may have lower governance standards.

Based on financials and CG (Corporate Governance) parameters we will screen ~400-450 names in the universe. We will have a Growth at Reasonable price (GARP) approach and a long-term focus to capitalize on the compounding that small businesses offer.

The fund will be disciplined about fund capacity to avoid large size becoming a hindrance to performance. It will be mindful of liquidity and market cap of underlying stocks Through extensive research process and in-person visits, we would shortlist this to a high-conviction portfolio of ~25-60 stocks.

Watch recent video where Chirag Mehta shares how despite the run-up in Small Caps, pockets of value exist and how investors can capitalize on the correction with a true-to-label small cap fund.

The NFO is currently open – Take this opportunity to grow your wealth that can make a big difference to your portfolio. Don’t miss the opportunity – the NFO closes on Oct 27, 2023.

Name of the Scheme	This product is suitable for investors who are seeking*	Riskometer of scheme
Quantum Small Cap Fund An Open-Ended Equity Scheme Predominantly Investing in Small Cap Stocks	• Long term capital appreciation • Investment in Small Cap Stockx	Investors understand that their principal will be at Very High Risk

^*Investors should consult their financial advisers if in doubt about whether the product is suitable for them.

^#The product labeling assigned during the NFO is based on internal assessment of the scheme characteristics or model portfolio and the same may vary post NFO when the actual investments are made.

For latest riskometer, investors may refer to the Monthly Portfolios disclosed on the website of the Fund www.QuantumAMC.com

Above article is authored by Quantum.

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