Investing in mutual funds has long been a popular choice for individuals looking to diversify their portfolios and maximise returns. However, recent observations by Zafar Sheikh (from Invesys Capital), shed light on an interesting trend.
Since the bull market took off in March 2023, the Small Cap 100 Index has surged by a remarkable 87%. In comparison, the top mutual fund in the same category only managed to gain 82%, and the category average stood at a mere 59.9%. Similarly, the Mid Cap 100 Index saw a growth of 66%, with the top mutual fund and category average clocking in at 68% and 53% respectively. These numbers beg the question: why are the average mutual fund investors falling short of the performance of the indices they’re tracking?
The answer lies in the inherent challenges posed by the size and structure of mutual funds. Large mutual funds, managing billions of dollars, face limitations when it comes to deploying capital effectively. For instance, if a fund has 40,000 crore to invest across 40 stocks, they will need to allocate a staggering 1,000 crore per stock. Executing large buy and sell orders of this magnitude can be a daunting task, especially in the small cap or mid cap market segments.
As the size of a fund grows, its performance is likely to suffer compared to smaller, more focused players. This is where smallcases come into play. Smallcases, which are significantly smaller in comparison to mutual funds, have demonstrated superior performance by leveraging niche strategies. Some examples of these smallcases include Mi 20, Mi 35, and HNI Wealth Builder, all of which have consistently outperformed category averages and even the index itself.
The key to the success of small cases lies in their ability to pursue different investment strategies within the same universe. While there might be multiple managers with large followings in the smallcase space, each manager employs a unique approach. By maintaining a smaller size and focusing on a specific niche, these managers can capitalise on market opportunities that larger funds may not be able to exploit effectively.
Of course, it is crucial to consider the tax implications of investing in smallcases versus mutual funds. While mutual funds benefit from a lower tax rate of only 10% if held for the long term, smallcases incur a 15% tax on short-term capital gains. However, if the potential returns from smallcases significantly outweigh the tax advantage of mutual funds, the trade-off becomes inconsequential. Why settle for a 59% return when the index is clocking in at 87% and smallcases can even surpass 105%?
These insights have not gone unnoticed, as a growing number of informed investors have begun diversifying their portfolios away from mutual funds in favour of smallcases. It is important to clarify that this shift does not imply that mutual funds are inherently bad investment options. In fact, mutual funds serve as an excellent entry point for individuals new to the market, offering diversification and professional management. However, once investors gain a deeper understanding of the market and wish to optimise their returns, smallcases present a compelling alternative.
Investors have a legitimate concern regarding the costs associated with mutual funds. As large mutual fund companies incur substantial administrative expenses, investors ultimately bear the brunt of these costs. For example, a fund may have a plush 500 crore building in Bombay for rent and employ a staff of 300. While these expenses are indirectly covered by investors, the transparency regarding where their money goes is often lacking. In contrast, smallcase providers operate on a smaller scale, leading to lower administrative costs, which can positively impact overall returns.
To sum up, the outperformance of smallcases compared to mutual funds can be attributed to their ability to circumvent the limitations faced by larger funds. Their smaller size enables nimble and focused decision-making, resulting in better investment returns. While the tax advantage of mutual funds remains a factor to consider, the potential for higher returns offered by smallcases often outweighs the tax implications.
Investors should take note of this alternative investment strategy and explore smallcases as a promising avenue for diversification and superior returns. It is essential to conduct thorough research and choose reputable smallcase providers with proven track records. By embracing this niche approach, investors can enhance their chances of maximising their investment outcomes and unlock the potential for greater financial success.
So, if you’re tired of mediocre returns from traditional mutual funds, consider exploring the world of smallcases. The opportunities are abundant, and the potential for superior returns awaits those willing to embrace a new investment paradigm.
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