Mahindra Manulife MF has launched an actively-managed new fund offer Mahindra Manulife Small Cap Fund. This adds a new option to the small-cap fund category which already has a dozen products and home to over ₹1.25-lakh-crore worth of investors’ assets (as on Oct-2022 end).

Compared to large-cap funds, the investments products in mid- and small-caps segments have stood their ground in terms of delivering alpha (excess return over benchmark). This is on account of a wide investment universe lending itself to unfolding of stock discovery premium, better active management styles, etc.

Will Mahindra Manulife Small Cap Fund continue the trend? Let’s find out. The NFO closes for subscription on December 5, and re-opens for continuous sale and repurchase from December 14.

About the fund house

Mahindra Manulife is a MF joint venture of Mahindra & Mahindra Financial Services Limited and Manulife Investment Management (Singapore) Pte. There is a clear stated focus on delivering investment products to semi-urban areas. It has nine equity-oriented products, including an international fund.

Why a small-cap fund now?

Besides the fact this will be Mahindra Manulife MF’s first small-cap fund, the reasons for launching such a fund are manifold.

One, the Indian economy is now picking up after Covid-19 impact. As a result, a virtuous growth cycle appears to be in place. Small-caps usually grow fast, despite their small size that put them at a disadvantage in comparison to large-caps. Yet, some small-caps have grown to mid-caps and large-caps over the past few years and, thus showing the way to robust wealth creation. This has helped small-cap fund deliver good returns and beat benchmarks easily than large-cap funds.

Two, small-cap stock valuation are, at least on paper, no longer in bubble stage. In March-April 2021, the BSE Smallcap 250 index was trading at 55 times trailing price to earnings. A few years back i.e. Dec 2018-Jan 2018, the index was trading at 100 times PE. That number is now below 20 times. Of course, calculating PE ratio of small-caps is fraught with complications since this is a 250-stock basket and also there is lumpiness in small-cap profitability.

Three, the scope of research and discovering good bargains in small-caps is good. Plus, small-caps are under-owned by institutions for various reasons, leaving a scope for price discovery. However, it must be noted that liquidity has a greater impact on small-cap stocks. That’s a risk which has played out many times and prospective investors have to wary about heightened levels of volatility.

Apart from the above reasons, small-caps offer a broader universe for investment. For instance, while 3 sectors (finance, IT and oil & gas) have over 55 per cent allocation in BSE 100, these sectors have less than 25 per cent allocation in BSE Small 250.

Our take

To run a successful investment product, stock selection holds the key. This is much more important for small-caps.

About 8-10 per cent of small-caps are suspended or are delisted in a 5-year period. Accounting quality of financials in some small-caps is sub-optimal. Also, the under-researched nature of such stocks means that publicly available data and good assessment of management quality are not readily available. Hence, guard rails for small-cap stock investing have to be much better than that of other stocks.

Mahindra Manulife aims to use the GCMV model, an internal investment research process used for determining the fair valuation of stocks which helps in estimating valuation gaps (fair valuation vis-a-vis market price).

Combining valuation gaps with catalysts can help in identifying re-rating candidates. Its equity universe is over 500 companies. If it is able to spot and build positions in small-caps that could be beneficiaries of structural reforms announced from time to time, or potential market leaders, or those that have a game-plan to achieve scale, good returns can be generated.

From a fund-house strength perspective, Mahindra Manulife MF’s equity investment team has an average experience of 15 years. There are 4 analysts, 3 fund managers and Chief Investment Officer. This gives us some comfort. The fund-house’s oldest equity scheme (ELSS) figures in the top-10 of 1-year and 3-year time frames and is placed above average in the 5-year period.

Similarly, its multi-cap fund is also doing well in the 1, 3 and 5-year periods. This is a good track-record to build on with the small-cap fund.