A problem of plenty is plaguing mutual fund houses. A rush to capitalise on the rapid rise of small-cap stocks in India’s stock market has resulted in a spurt of inflows into schemes dedicated to investing in them. Consequently, some fund houses have been forced to restrict inflows.
On Thursday, Nippon India Mutual Fund announced that it would stop lump sum inflows into its small-cap fund, the largest in the category. The announcement came just days after Tata Mutual Fund restricted inflows into its own small-cap fund. Both fund houses are allowing systematic investment plans, which deploy an investor’s investments in a staggered manner, to continue.
At the end of May, Nippon India Small Cap Fund had around Rs 28,780 crore assets under management, while Tata Small Cap Fund had Rs 4,460 crore.
In the notice, Nippon India Mutual Fund said the step was warranted “considering the recent sharp rally in the small-cap space and increased investor participation through high-ticket investments”.
Indian investors have flocked to the small-cap category on account of a substantial rise in these stocks. In 2023 so far, the Nifty Smallcap 100 index has gained close to 15% returns, which are double that achieved by the benchmark Nifty 50.
In a bid to participate in the rally, investors have pumped in close to Rs 12,400 crore into such schemes in the first five months of the year. That’s over a fifth of the total inflows into actively managed equity mutual fund schemes this year, according to data released by the Association of Mutual Funds in India.
At the end of May, assets under management in small-cap funds stood at Rs 1.54 lakh crore, up 18.5% since the start of the year.
Investors have favoured mutual fund schemes that invest in the broader end of the market, with inflows into mid and small-cap funds accounting for 36% of the total, till May.
No Value?
The decision by two mutual fund houses to pause lump sum investments into small-cap funds has led some to ask whether the fund managers are not seeing enough opportunities in the category. But, the decisions were less about valuation and more about liquidity, says Chakri Lokapriya, chief investment officer and managing director at TCG Advisory Services Pvt.
“The small-cap category is very large, with over 600 companies. But out of this, the liquidity is restricted to the top 100-200 stocks,” Lokapriya said. What this means is that the traded volume of a vast majority of the small-cap stocks is not large enough to allow mutual funds to invest in them.
But, there are still several stocks in the category that continue to trade at valuations that are far below the average of their previous top cycle, Lokapriya said. “In fact, there are a number of stocks that are trading at between 10 to 14 times their one-year forward earnings."
What Should Investors Do?
Investors can choose to continue their systematic investments into mutual fund schemes, while this avenue to invest continues to remain available.
However, this is an opportune time for investors to introspect about the reason they are choosing small-cap funds, according to Harshvardhan Roongta, co-founder, Roongta Securities Pvt.
“We have always maintained that small-cap funds are not the best way to take exposure to small-cap stocks,” said Roongta. “In these schemes, fund managers are mandated to hold at least 65% of assets under management in these stocks. In our opinion, flexi-cap funds are a better option for individuals, because the rules allow fund managers to shift allocation between different market capitalisations, based on the prevailing market dynamics."
Roongta said that investments into small-cap stocks are all about cherry-picking and the requirement to invest in a specific proportion is antithetic to that.
“If you had invested because of the past returns, this is a time to introspect and see if you want to be in the small-cap fund category. If you believe that you don’t want to be in small-cap funds, this is the best time to exit,” he said, adding that a lump sum investment can then be made in a flexi-cap fund.
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