Thrills and chills

In the ongoing bull run, small caps have once again come in the limelight thanks to their ability to give double-digit returns in a matter of months or even days. Since April this year, the S&P BSE 250 SmallCap TRI has returned 55.6 per cent as of October 2020.

However, if one expands the horizon the returns from small caps don't appear all that attractive. The five-year and 10-year returns of the BSE 250 SmallCap TRI stand at just 4.12 and 2.72 per cent. This suggests that small caps are not able to sustain the gains and a slump in the market hits them badly, unravelling their past performance. This results in disappointment for long-term investors.

However, given their vast universe (all companies beyond the top 250 companies), in small-cap stocks, the scope of alpha generation through stock selection is immense. That's why investing through small-cap funds is rewarding to profit from this group of stocks. A seasoned fund manager can help you navigate this tricky space more effectively.

AUM trends
In 2020 (till October end), the small-cap category of mutual funds has seen its AUM rise by about 10.22 per cent (about Rs.4,959 crore) year to date. More than 62 per cent of this has come from net inflows, mainly at the start of the year, and the remainder through the returns generated. At about Rs.53,500 crore, the smallcap category AUM makes up about 1.88 per cent of the total industry AUM.

Post the crash in March, a few prominent funds in the category had lifted restrictions on inflows as the valuations turned attractive and in anticipation that the redemption pressure may increase. The markets staged a smart recovery from late March, which resulted in the category AUM growing by about 50 per cent since March-end, mostly backed by performance.

How did they perform?
There were talks early this year that small caps would be out of the slump considering their underperformance in the previous two years. Though with an average return of more than 9 per cent so far this year, we might be seeing signs of recovery to some degree, small caps did dive about 28 per cent in the month of March. The three-, five- and seven-year SIP returns (as of October 2020) for the category stand at 3.7, 4.9 and 8 per cent, respectively, whereas the trailing returns for the same durations are -2.9, 7 and 16.4 per cent.

The sudden recovery in the market over the past few months has led to the trailing returns for lumpsum investments looking better than SIP returns. However, as in other equity categories, invest in small-cap funds only through SIPs, given the volatility in this category.

What we think
At Value Research, we have always maintained that small-cap funds play a supplementary role in your portfolio and should not have more than 10-15 percent. However, those who cannot tolerate high volatility can do without this set of funds. They should stick to plain vanilla multi-cap funds, which also provide you some small-cap exposure.