SBI Small and Midcap Fund bagged the Morningstar Fund Award 2018 in Best Small/Mid-Cap Equity Fund category, beating L&T Midcap and Mirae Asset Emerging Bluechip.
R Srinivasan, Head – Equity, SBI Mutual Fund, tells Morningstar that capping the fund size at a reasonable level enabled them to go further down the curve where some good research arbitrage opportunities existed.
This fund has been a consistent performer relative to peers. What has worked in your favour?
Well, for one, the whole category has done very well; there has been significant diffusion in performance down the capitalisation curve with mid-and-small caps doing far better than large caps, in general. This trend helped us as well. Two, we capped the fund size at a reasonable level which enabled us to go further down the curve where some good research arbitrage opportunities existed. Third and probably the most important was our willingness, as a house, to spend time and effort on this space in search of excess returns. Specifically, top return attributors (among holdings) over the last three calendar years have been Graphite India, Manpasand Beverages, RK Forgings, Relaxo Footwears and Avanti Feeds. Except Manpasand and Relaxo, the other ideas were based largely on valuations. We got lucky on Graphite India.
Our thesis was largely capital protection based on a strong balance sheet, an oligopolistic sector globally (getting further consolidated) and absolute valuations. Graphite Electrode prices hit the roof and the company is seeing a cash flow bonanza and the same has reflected on the stock price. Manpasand Beverages was a bet largely on the promoter and his track record. RK Forgings was cheap and at an attractive point in the cycle. Relaxo Footwears and Avanti Feeds both had strong competitive advantages and Avanti was really cheap.
The mid and small cap segment has performed extremely well in the last few years. How do you foresee the growth in this space going forward? In which pockets are you seeing opportunities?
I don’t know how to answer this question! When you talk mid-and-small, it is the entire universe sans the top 100 stocks, say. This is not a homogenous group. How do you generalise? Just the BSE Small Cap index has 842 stocks. One way to look at it is the trend in the market. I guess, mid-and-small caps tend to have a higher beta relative to large caps. So, they tend to fall more when the market (read the Sensex) falls and vice versa. In which case, it’s just about taking a short-short view on the market and allocating accordingly. We are almost entirely bottom up, hence, it’s tough to identify analogous pockets of opportunity.
To add, it is always a good time to be in mid-and-small caps. If you want to build a 25-30 stock portfolio, this is where the universe is and more importantly, the research arbitrage.
Many fund houses are launching closed end funds focused on mid and small cap themes. As a fund manager, which structure (closed end or open end) is ideal for managing a mid and small cap fund? What are the pros and cons of each of these structures?
Practically speaking, it shouldn’t matter much. Indian mutual fund schemes are largely retail and fund volatility, even in the worst of times, is quite low though I say this with my limited experience. If you look at the liquidity profile of most of our funds, they are on the lower side by global standards. But, it hasn’t mattered! I’d be agnostic between an open and a closed structure. Come to think of it, a better idea is to optimise the pros of both structures. Run an open-ended fund and open-close it based on the availability of ideas/opportunities.
As compared to blue-chip stocks, small cap stocks are not well researched and tracked. In such a scenario, what parameters do you look for while building your portfolio?
Broadly speaking, we look at five variables when selecting a stock: 1) competitive advantage 2) return on capital 3) growth 4) management and 5) valuations.
While you would ideally want all of these to be in your favour, they typically never are (unless it’s a really bear market) and hence, you’ve got to figure out the relative intensity of each of these factors and get an overall picture. It’s true small cap stocks are under-researched but therein lies the opportunity. The process itself is not conceptually any different than what it is for large caps. The difference is in terms of the time and effort required and the high rejection rate.
Given the inherent volatility and risks involved in the mid and small cap segment, what strategies have you put in place to mitigate risks in this fund?
The risk is higher volatility in the short term. However, volatility reduces significantly with time. We advise investors not to come in with a short-term perspective. Liquidity is the bigger risk. And, the fact that returns, nowadays, are a function of a lack of liquidity rather than the other way around. We are wary of it and try to mitigate it in two ways: one, by looking for ideas where loss of capital is minimal and two, by demanding a large probability outcome.
What would be your advice to investors wanting to invest in this space at this juncture?
For me, it’s a rhetorical question! I’m happy putting my money in mid-and-small caps, now and forever. Not because they are mid-and-small caps but because some of them are good businesses run by great guys. To be honest, I haven’t really understood this business of determining risk in a portfolio based on market capitalisation.
Morningstar Fund Awards: A look at the winners from the past
Nominees for the Best Fund House Awards 2018
Morningstar Fund Awards 2018 category nominees
