Placing Small Bets

Small-cap funds help spread risk, yet make gains.

If you had invested Rs 1 lakh in Crompton Greaves on 1 January 2002, your money would have grown to Rs 65 lakh by now. Back then, Crompton Greaves was a small capital goods company with a market capitalisation, or market cap, of Rs 115 crore and a stock price of Rs 1.80.

It has been one of the biggest wealth creators in the Indian stock market and given 52 per cent annualised return over the last 10 years. The company had a market cap of Rs 8,300 crore on 28 November 2011 while its stock was trading at Rs 123.

On 2 January 2002, Sesa Goa had a market cap of Rs 99 crore and its stock was at Rs 1.28. On 28 November 2011, the stock was trading at Rs 174 and the company's market cap was Rs 16,000 crore.

Scores of once small companies have over the years grown big, giving investors a 30-50 per cent annual return over 10-15 years and creating fortunes for investors. However, more often than not, we find ourselves at the wrong side of the fence and regret our inability to spot such stocks on time.

The number of small-cap stocks is large and finding a quality stock that can give high returns over a long period is tough even for equity analysts. One reason is that such stocks usually have a short history and are not tracked by many analysts and brokerage houses. Then there are risks such as low liquidity, governance concerns and competition from larger players.

If these factors scare you but you still want to gain from the upside potential of such stocks, small-cap mutual fund schemes are an ideal choice for you.

A typical small-cap fund invests over 50 per cent money in stocks of small companies. However, the fund manager can lower the exposure depending on market conditions. Mid-cap stocks form 25-35 per cent of the portfolio. A small portion, usually less than 10 per cent, is invested in large-cap stocks. Mutual fund schemes that invest a large part of their money in small-cap stocks also carry a higher risk.

RISK-RETURN TRADEOFF
It's a challenge for the fund manager to build a portfolio of quality small-cap stocks as the number of such companies listed on exchanges is huge. Also, many of them are little-known.

"The number of small companies listed on Indian stock exchanges may run into a few hundred. Out of this, 30-50 companies can be selected for investment. The challenge is that many of them may be under-researched by research/brokerage houses. One may have to rely extensively on primary research," says Dhiraj Sachdev, senior vice president and fund manager, equities, HSBC Asset Management India.

Another risk is low volumes, which makes these stocks illiquid. This means the fund manager may not be able to sell the shares as and when he wants. Small-cap funds are thus prone to liquidity risk. For example, the average number of daily traded shares in the CNX Small Cap index was 75 million compared to CNX Nifty's 141 million during the year ended 30 November 2011. CNX Nifty comprises large-cap stocks. Anyone investing in small-cap funds, therefore, should have a long investment horizon.

Small-cap companies see sudden rise and fall in stock prices and this is reflected in the net asset values, or NAVs, of funds investing in such stocks. "Due to small size, such companies are more prone to volatility," says Vinay Paharia, fund manager, Religare Mutual Fund. Paharia manages Religare Mid and Small Cap Fund.

Therefore, only investors with appetite for high risk should go for such funds. Besides, small-cap funds should form a small part of your portfolio.

Mutual funds investing in small-cap stocks can minimise the risk by diversifying across companies and sectors. Since mutual funds are managed by professional managers supported by teams of analysts and researchers, they are in a better position to select the right stocks, diversify across sectors and companies and react swiftly to changes in equity market conditions.

HOW THEY PERFORMED
There are four mutual fund schemes-Sundaram Select Small Cap, Reliance Small Cap, HSBC Small Cap and DSPBR Micro-Cap-which invest primarily (50 per cent or above) in small-cap stocks. None of them have a track record of five or more years. Only Sundaram Select Small Cap and HSBC Small Cap have completed three years.

In the one-year period up to 9 January 2012, the NAV of these funds fell 25 per cent on an average compared to the 38 per cent drop in the BSE Small Cap index. HSBC Small Cap fund fared the worst as its NAV dropped 42 per cent.

Sundaram Select Small Cap was the best performer with a return of -16 per cent. Sundaram Select Small Cap is a close-ended fund and its units are on offer for a limited period. Mid- and small-cap funds performed slightly better on the downside with an average -19 per cent return in the one-year period compared to the -29 per cent return delivered by the BSE Mid Cap index.

The average three-year return by small-cap funds as on 9 January 2012 was 25.5 per cent compared to 24 per cent by mid- and small-cap funds. The average return of large-cap funds in the past one year has been -19 per cent. The average three-year return by large-cap funds was 17.518 per cent on 9 January 2012.

ARE YOU GAME?
Those who wish to invest in small-cap funds should do so only if they have a long investment horizon and tolerance for volatility. Small-cap stocks suffer the steepest falls in a bear market and rise the most in a bull market. An investor should stay put for at least three-five years to allow the fund to gain from at least one bull run.

A small-cap fund will generally witness more frequent changes in its portfolio than a large-cap fund. It's better to go for schemes with a low turnover ratio, which measures how much the portfolio has been churned. A higher ratio means a higher trading cost.

Buy funds with lower volatility, which is measured by standard deviation (SD) and beta. The higher the SD and the beta, the more volatile the fund is. A better way to judge the performance of the fund is to check its Sharpe Ratio, which measures the risk-adjusted return. The higher the Sharpe Ratio, the better is the fund's performance. R-squared is the proportion of the fund's portfolio that moves in line with the benchmark index.

You can check these ratios in fund factsheets released by fund houses every month. These factsheets are also available on websites of mutual funds.

"Small-cap funds are good only for a portion of the portfolio. These funds are more volatile than large-cap funds. While there could be a possibility of higher returns from these funds, I think only a small percentage of wealth should be invested in such funds," says Raghvendra Nath, managing director, Ladder up Wealth Management.

There are many companies in the small-cap space that may become success stories in the future. Investing a small portion of your savings in the small-cap theme through mutual funds may give you a pleasant surprise.

Source: http://businesstoday.intoday.in/story/invest-small-cap-mutual-funds-companies-good-returns/1/21880.html

Neighbours are not financial wizards

Love thy neighbour is a common adage, but most people extend it to include financial decisions as well. For instance, a sustained rise or a sudden fall in the stock market is often observed due to frenzied buying in bubbles and selling in crashes.

In fact, as a recent study by Ameriprise Financial India shows, Indian investor even used this ‘follow the neighbour’ formula for purchasing insurance, gold and other financial instruments as well.

There are strong preferences for certain products in specific cities. No wonder, every city has its preference for certain instruments. Mutual funds and gold are preferred by Delhi, stocks are favoured by Mumbai, Chennai wants real estate and Bangalore is into debt. The survey was done between the age group of 28-45 and with an average annual household income in excess of Rs 12 lakh.

TWO DIFFERENT FAMILIES: YOU AND YOUR NEIGHBOURS

• Goals, time horizon will differ
• Risk-taking ability will differ
• Financial commitments will differ
• Age group may differ
• They share successes, not failures
• ...then, why follow them?

However, following the investment decisions of one's neighbour or friends or even relatives is not the best strategy. The culture of collaboration does not work while making financial decision for your family. There are a host of other reasons that should be considered while making investment decisions.

Your reason to save or invest may not be the same as your neighbour's. The other family may be investing for their child's school education, while you need it for higher education — clearly, the amounts required would be vastly different. For them, a 10-year debt instrument may work, whereas since the requirement is much more, you may have to opt for equity.

More importantly, your monthly outgo may be completely different. As financial planner Suresh Sadagopan says, individuals should count their priorities before copying. "When you have commitments, having cash in hand is important. And you have to account for it. But many don't," he says. Do not invest because somebody else is investing and he/she thinks you are missing out on something big.

Your neighbourhood uncle at 50 may be looking to earn 8.5 per cent on a 10-year NHAI bond, because it means a nice little safe corpus at the age of 60, when he retires. For you, at 30, it makes little sense. If the stock market falls further, there may be a good opportunity to enter and stay invested for the next 20 years.

Conversely, if you are 50, it makes more sense to stay away from high-risk, high-return products, because capital erosion is the last thing you want. Going with the good old bank fixed deposits or post office deposits may keep the corpus safe with steady returns.

Random investment is something that one should be wary of. The Ameriprise study talks about most individuals investing through real estate, insurance, gold and so on. But, none of these investors know if the asset class suits their profile.

However, you need to match your requirements to an asset class before investing. "For instance, real estate and start-ups could work wonders for some individuals, while it may end up being disastrous for others," explains Bimal Gandhi, chairman of Ameriprise Financial India. Therefore, do not pick a scheme just because good friends have done so.

Most important: It is unlikely that many will discuss their investment failures with you. Most will tell you about their successes. Certified financial planner Anil Rego says individuals see how their friend(s) have made money in an asset class/scheme. And then invest. "But, they fail to understand that this may or may not be the right time to enter that scheme. A classic example is gold and many are more than willing to enter gold now just because many have gained from it in the past year," he explains.

Source: http://www.business-standard.com/india/news/neighboursnot-financial-wizards/462019/

Delays are costly in retirement planning

People exceedingly depend on provident funds and fixed deposits to provide for their requirements post retirement.

Whether or not you make other New Year resolutions, here is one you should make. Don't postpone savings or investments.

The new urban lifestyle has made people more prone to spending than to saving or investing.

With India Inc prospering and young professionals getting handsome packages, people today are financially independent at a younger age. As a result, most of them become complacent about their long-term finances.

While everyone is aware of their financial needs and aspirations, only a few assess their ability to meet critical long term goals - saving for retirement and saving for child's education, to name two key ones.

Yet, procrastination and delay in formulating and implementing a proper financial plan can have serious repercussions on future financial goals. Postponement in planning can result in a higher financial burden in the later stages of life, and one may not be able to save enough for long term goals.

Let us understand the cost that the delay can cause with the help of an example. Keeping in mind the current inflation rates, it is estimated that an MBA degree that costs Rs 4,00,000 today will cost Rs 20,00,000 in 15 years time.

How many parents will be financially ready to bear this cost when required for their child without dipping into retirement funds? According to Aviva Young Scholar Insights, a recent survey conducted across 12 cities in India, it was found that investment for a child's education is the topmost priority for 72 per cent of Indian parents.

But 81 per cent of parents also admitted that they have no clue on how to go about meeting the cost of their child's education. It then becomes even more important for young parents to start saving early so that the expense for their child's education doesn't become a burden later.

Apart from saving through conventional methods like a savings bank account, parents can choose insurance policies to protect their children's future.

Insurance ensures that the child's education is unhindered, in case the parents are no longer around. There are also child plans from other investment options like mutual funds which aim at creating a corpus.

Retirement blues

Similarly, due to lack of a formal social security system in India, retirement is another top area of concern for 45 per cent of the people in India.

People exceedingly depend on provident funds and fixed deposits to provide for their requirements post retirement. But keeping in view the current rate of inflation, the steep rise in the cost of real estate and the substantial rise in the overall cost of living in India, these savings alone will not suffice.

For a comfortable lifestyle post retirement, in absence of a regular stream of income, one needs to start planning for it right away.

Here again, it is easy to save for retirement in the initial years of one's career, as there is no pressure to support a growing family and you don't have high medical expenses. However, if you delay investing even by a year, then there is a ‘cost of delay'.

Take a typical pension plan offered by insurers. A 30-year-old man with a target retirement fund of Rs 25 lakh wishing to retire at 58, has to start investing close to 24,000 an annum by way of premium.

However, if he delays this by five years and starts investing at the age of 35, he will have to pay close to Rs 38,000 an annum for same accumulated amount of Rs 25 lakh, an increase of 58 per cent. This is based on an assumed net investment return of 8 per cent an annum.

Nowadays, people can look at several options for saving for retirement like pension and retirement plans by insurance companies, mutual fund schemes.

These, when combined with PPF and fixed deposits can give an individual a balanced financial portfolio to attain the retirement goals.

Thus, judicious and proactive financial planning will make sure that you have enough resources with you in the future, to fulfil your child's aspirations and take care of your retirement needs. Start planning for future financial needs without any further delay.

Remember, while the key to successful planning is to start early, at the same time, it is never too late to get started.

Source: http://www.thehindubusinessline.com/features/investment-world/article2763836.ece?ref=wl_features

How to select mutual funds

How does one select a mutual fund? The Indian mutual fund industry has come a long way, with the assets under management (AUM) growing at an annualised rate of 20% between September 2006 and September 2009. It has moved from offering traditional equity and debt schemes to specialised products, such as funds of funds, arbitrage funds, asset allocation funds and exchange traded funds (ETF). All these make it difficult for investors to select the scheme that suits their needs.

Let us look at some of the parameters that should be considered while selecting funds.

Investment objective & risk profile: The investment goal of the fund must coincide with that of the investor. The objectives can be defined in terms of tax planning, regular income, high returns, long-term planning, etc. Equity funds are more tax-efficient compared with debt funds, short-term debt funds aim at regular income, whereas closed-ended equity funds aim at long-term capital appreciation.

The fund should be chosen according to the investor's risk tolerance. The objective of high returns is generally associated with high risk. The Association of Mutual Funds in India (Amfi) defines three types of risk tolerance levels: low risk or cautious, moderate risk or cautiously aggressive, and high risk or aggressive.

Low-risk investors should consider debt funds, which invest in government securities or high rated debt papers. Moderate-risk investors should consider index funds, balanced funds and asset allocation funds. High-risk investors should look for equity funds (diversified and specialised), offshore funds and mid-cap funds.

Fund performance & management: Though the past performance of a fund does not define its future performance, it is important to consider how it has performed with respect to its benchmark or other similar funds. A fund should be compared with the same category of funds. So, the performance of a mid-cap fund cannot be compared with that of a large-cap fund as the former is more volatile compared with the latter.

Past performance also helps in assessing the quality of fund management, the skills of the fund manager and his team. The stock picking and market timing abilities of the manager can be judged by comparing the fund performance with its benchmark.

The funds that perform better than their benchmarks are considered outperformers, whereas the funds that yield less than their benchmarks are underperformers.

Fund size: The size is important because a very large fund often faces difficulties in the optimum deployment of its corpus, which, in turn, negatively impacts its performance. On the other hand, a very small-sized fund is constrained with the problems of high costs. Therefore, one should go for a mid-sized fund as it ideally balances the investment flexibility and costs.

Fund costs: These involve the operating costs of running a fund and include marketing and selling expenses, audit fees, custodian fees, etc. These costs can be gauged by looking at the fund's expense ratio, which is reported in its annual report. The expense ratio should be compared with similar funds as those with high ratios significantly impact the long-term investors due to the effect of compounding.

Source: http://economictimes.indiatimes.com/personal-finance/mutual-funds/analysis/how-to-select-mutual-funds/articleshow/11315080.cms