Principal Small cap Fund offering comes from the underlying belief of fund houses that there is money to be made in small caps. Whether this money is for the fund or for you the investor, remains a question.
Having worked with 100s of clients and interacted with many others, my view is that most investors are not ready for a dedicated small cap fund.
The patience that is required to make money with a small cap fund is plain absent. The investor is not ready to face the drawdowns – sometimes as much as 50%. If the fund performs poorly on past 3 year or 5 year returns basis, there is an urge to move out and invest in another fund with a better performance.
The fund houses / AMCs understand the investor behaviour very well and play it accordingly. Just a little portion invested in large caps or mid caps, over and above the mandatory 65% into small caps, does the job. It smoothens the NAV, lowers the volatility and dresses the ratios well.
You still get compared with other small caps and stand out. The perception management is as important as fund management within the universe.
A pure small cap fund which gravitates towards micro caps, and is subject to more pain than the other finely adjusted similar fund, loses out in the perception battle.
In this scenario, when being a pure small cap can spell your doom and take the investor away, the only way investors will stick is by being upfront and transparent about what you stand for, what the fund stands for and clearly telling who should not invest?
Where does Principal Small cap Fund stand?
As a regular reader of the blog, you know the answer already. In fact, I had written a Funny Money note on a small cap NFO or New Fund Offer. I am humoured to say that the note as it is applies without change to the Principal Small cap fund NFO.
The no. 1 reason Principal MF is doing this NFO is because it has a vacancy to fill. For all the funds allowed by SEBI, the fund house does not have a fund in the small cap category. Time to do it!
The no. 2 reason is that there is a general view in the market about small cap valuations moderating from earlier. Some of them are good businesses available for adding to the portfolio. For all the fundamental talking, professionals also find it difficult to ignore macro events / non events. In this case, it is the elections 2019. A lot of them are banking upon a post-election uptick to take their careers forward.
The no. 3 reason is that the distributor community needs to be kept engaged with a new product, new offering, something new to talk about. The investors keep asking “what’s new” and the distributor can reply “here’s something for you.” (Rhyming is incidental)
From an investor’s point of view, none of these are good reasons to invest in a small cap fund, more so in this fund. Of course, the bigger reason is that you are not ready for a small cap fund.
Like it or not, investor seeks a straight line return even from an equity investment. A time horizon of 5, 10 or 15 years is easy to say but difficult to put into practice. A few months or years of staying behind makes you nervous.
Avoid the pain now, don’t invest.
Investing in equity mutual funds require a horizon of at least seven years. For small caps, the volatility is expected to be more compared to large caps or mid caps. Thanks for sharing a great article keep posting.
Thats a very frank and straight-forward opinion on the NFO. I think with increase in the number of funds in SmallCap category, the volatility will be much higher. In the event of a crash, these funds will be deserted very quickly and the smallcap stock valuations will go down deeper. Similarly on the upside, the valuations will peak faster. All of this because there isn’t many quality smallcap stocks to invest.
On the other hand, too much money chasing the limited stocks, could keep them afloat for much longer than expected. “Greater Fools’ theory works beautifully.
Yes it might only if the investors are sensible to hold on. We know all hell will break lose if panic sets in. Previously during bear markets smallcap funds could shift substantial money to mid and even large caps because there were no clear mandates on the investment. But with a mandate of 65% in smallcap stocks no matter what, the falls will be deep and very damaging. Small cap stocks fall more than 50% during bear markets.
Meanwhile it a good time to evaluate 1 year performance of existing smallcap funds.
Good point. How do you plan to evaluate 1 year performance of small cap funds?
Of course the 1 year returns of the smallcap funds can now be compared with each other because they would have followed the SEBI investment mandate in the last year. Not sure about the risk though. More the % of investment in smallcap stocks (over and above 65%), higher the risk? I don’t know.