Weekly Musings – NFO Pick (Bandhan Nifty Smallcap 250 Index Fund)

11 Dec 2023 , 09:18 AM

SMALL CAP INDEX FUNDS – HOW THEY FIT IN

The Bandhan Nifty Smallcap 250 Index Fund NFO is an opportunity to invest in the small cap universe in India through a passive engine. When we talk of small cap stocks, it adheres to the standard definition of small caps, as defined by SEBI for the mutual fund industry. All stocks in the universe are ranked on market. The stocks ranked from 1 to 100 will be classified as large caps while the stocks ranked from 101 to 250 would be ranked as mid-caps. The stocks ranked 251 and beyond will be the small caps and that will be the focus of the Bandhan Nifty Smallcap 250 Index Fund NFO. The only difference is that it will adopt a passive approach, instead of an active approach. This will ensure that costs are kept in check and the ROI is consequently enhanced.

In India small caps have outperformed over a longer time frame for a variety of reasons. Firstly, these companies tend to be focused single business companies. Due to their size, these are companies that typically grow on client money and do not carry bloated debt or equity in their books. Hence, most small companies tend to enjoy better profitability and solvency ratios compared to their large cap counterparts. Also, the small caps have the potential to become multi-baggers when they transform into mid-caps and large caps. That is where the opportunity lies for investors. They may be riskier than the large cap funds, but that is the price you pay for alpha. That is precisely the intent of the Bandhan Nifty Smallcap 250 Index Fund NFO. It is to give portfolio alpha through a Beta approach.

WHAT IS THE EXPOSURE THAT SMALL CAP INDEX OFFERS?

One of the standout features of investing in a portfolio of small cap stocks is that it can give you exposure to many high growth industries that you would not get access via large caps. Here are some key pointers to note. Some sectors like hospitality, realty, specialty chemicals, auto components, defence, financial intermediation etc are not available in the large cap space. Here is a list of key themes you can play via the small cap story.

• The highly powerful Make in India (PLI) theme can be effectively played through small caps. These include themes like energy transition, import substitution, and export orientation. These include specific sectors like auto components, specialty chemicals, textiles, consumer electronics etc.
• The second theme you can tap through small caps is digitization. You can look at the internet as a good proxy for playing these theme. You have several listed alternatives in niche segments like travel portals, ecommerce portals and transaction and payment processing companies, which are available in the listed universe.
• There are themes like green energy, emerging healthcare and financialization of savings; that you can play through small cap stories like listed exchanges, demat intermediaries, brokerages, financial advisors, green hydrogen, solar panels, niche hospitals, diagnostics etc. The list can go on but the message is quite evident.
• Finally, you can also tap the traditional themes like domestic consumption and manufacturing through the small cap space. You have options like hospitality, auto industry, industrial products etc which can be accessed through the small cap space.

The core idea of the Bandhan Nifty Smallcap 250 Index Fund NFO is to be able to passively play all such themes under one single umbrella.

HOW THE PASSIVE SMALL CAP THEME CAN ADD VALUE

While the passive approach of index funds lowers the cost and simplifies the access, there are some distinct advantages in the small cap theme.

1. If you look back at the multi-bagger stocks in India, 70% of them were from the small cap space, with just 18% from the mid-cap space and 12% from the large cap space. Out of the NSE-500 stocks, nearly 269 stocks multi-baggers and there was a disproportionately high share of small caps among these.
2. If you look at the last 19 years of data, then small caps have been the outperformers in 9 out of these 19 years while large caps have outperformed in 7 out of these 19 years and mid-caps in 3 years. What is more important is that the years when the small caps outperformed, it did so with a huge return gap over the other categories.
3. Since mid-2019 (just before onset of COVID), a total of 30 companies have transitioned from small caps to mid-caps while 1 company transitioned from small cap to large cap. That is a lot of value created over a five year period. Period of high growth, as is expected to come about, are considered the best period for small caps.

Small caps are not just about returns, but also about he probability of delivering excess returns. That is where they manage to deliver better risk-adjusted returns over the long run.

WHY PASSIVE APPRAOCH TO SMALL CAP UNIVERSE

The Bandhan Nifty Smallcap 250 Index Fund NFO is a passive approach to participate in the small cap universe in India. While even an active approach to small caps can be taken, here are some distinct reasons that favour a passive approach to small cap stocks.

• When it comes to active small cap funds, investors have to choice the right fund, choose the right strategy and handle diversity of returns, which ranges from 15% to 42%. These problems can be easily addressed with a passive approach.
• The index based passive approach gives a much higher exposure to small cap stocks. For example, an active small cap fund typically has a median exposure of 69% to small caps. On the other hand, the Bandhan Nifty Smallcap 250 Index Fund will have 98% exposure to small caps. It is small cap fund in the real sense of the term.
• The Nifty Smallcap 250 index is carved out of the Nifty 500, so quality checks are done. However, it excludes 100 large caps and 150 mid-caps, so the focus is purely on small caps. It is also dynamic due to half yearly review.
• Across different time frames like 3 years, 5 years and 10 years, the small cap index has given higher returns than the large caps and mid-caps, with volatility levels that are at par with large and mid-caps. That means, higher risk adjusted returns on small caps. If you take a SIP approach to the Small Cap 250 index TRI, the CAGR is 30.2% over 5 years and 18.6% over 10 years, giving clear indication of long term value creation.
• The small cap 250 index is more diversified in the sense that its performance is less dependent on a handful of stocks or a handful of sectors. The current P/E of 25.6X is sharply lower than the 5-year average P/E of 36.3X. This has been supported by 45% growth in earnings of small cap companies CAGR over last 3 years.

The bottom line is that the Bandhan Nifty Smallcap 250 Index Fund NFO would be a great fit for an investor with a higher risk appetite, a longer term investment horizon and willing to add an aggressive strategy to their portfolio.

HIGHLIGHTS OF THE BANDHAN NIFTY SMALLCAP 250 INDEX FUND NFO

Here are some key takeaways that investors should know about the NFO.

• The Bandhan Nifty Smallcap 250 Index Fund NFO opens for subscription on December 12, 2023 and closes on December 19, 2023. Nemish Sheth will be the fund manager for the Smallcap Fund.
• It is an open ended mutual fund scheme which is classified as a passive equity mutual fund scheme under SEBI classification norms. Any equity fund runs the risks of market volatility, business cycles, portfolio quality and passive funds have the added risk of tracking error. Small cap funds also have added size risk.
• The performance of Bandhan Nifty Smallcap 250 Index Fund will be benchmarked to the Nifty Smallcap 250 TRI index. The TRI index is total returns index, which not only factors the capital gains but also the dividends received by the components of the index.
• The objective of Bandhan Nifty Smallcap 250 Index Fund is to generate long term capital appreciation by holding a portfolio mirroring the Nifty Smallcap 250 index through a passive approach and minimizing the tracking error.
• Lumpsum purchases in the NFO entail a minimum investment of Rs1,000 per application. Additional applications can be done of minimum Rs1,000 while, SIP investment can have a minimum base of Rs500. There will be no entry or exit load.
• The Bandhan Nifty Smallcap 250 Index Fund offers Regular Plans and Direct Plans to investors with the TER adjusted accordingly. In addition, the fund also offers investors the growth option, and IDCW options to investors. Investors must evaluate tax implications of the various options before opting for the same.
• While there are no lock-in restrictions, it is suggested that ideally the Bandhan Nifty Smallcap 250 Index Fund be held for a minimum period of 5-7 years, to derive the full benefits of varying equity cycles and to counter the added risks of small cap stocks.

It must be noted that in the case of equity funds, the dividends are taxable at the marginal rate of tax applicable to the particular investors. The capital gains are taxed at concessional rates of 15% for short term capital gains and 10% for long term capital gains (above a threshold of Rs1 lakh of capital gains).

UNDERSTANDING NON-NIFTY PASSIVE GENERIC FUNDS IN INDIA

Here is a quick look at the other existing mid-cap and small cap index funds in India and their performance over last 1 year and since inception. These fund have been ranked on their CAGR returns since inception.

Scheme  Name	NAV Regular Plan (₹)	1 Year  Returns (%)	Returns since  launch (%)	AUM  (₹ crore)
Edelweiss Nifty Midcap150 Momentum 50 Index Fund	13.97	39.46	38.72	112.29
SBI Nifty Smallcap 250 Index Fund	14.60	36.99	37.77	424.44
Edelweiss Nifty Smallcap 250 Index Fund	13.85	36.77	37.50	21.93
Nippon India Nifty Smallcap 250 Index Fund	26.24	36.75	35.90	931.56
Tata Nifty Midcap 150 Momentum 50 Index Fund	14.05	37.70	34.99	229.65
SBI Nifty Midcap 150 Index Fund	14.17	33.80	34.36	240.49
Mirae Asset Nifty Midcap 150 ETF	16.59	35.03	30.28	574.60
Motilal Oswal Nifty Smallcap 250 Index Fund	29.16	36.94	28.58	590.77
Motilal Oswal Nifty Midcap 150 Index Fund	28.63	34.00	28.02	1,189.63
Navi Nifty Midcap 150 Index Fund	15.28	33.18	27.50	88.95
Axis Nifty Midcap 50 Index Fund	15.10	39.56	27.45	180.13
ICICI Prudential Nifty Midcap 150 ETF	168.12	34.91	26.70	247.11
Kotak Nifty Midcap 50 ETF	127.63	41.23	25.59	23.56
Nippon India Nifty Midcap 150 Index Fund	18.65	34.02	24.94	996.95
Aditya Birla Sun Life Nifty Midcap 150 Index Fund	18.13	33.94	24.78	142.11
Nippon India ETF Nifty Midcap 150	168.42	35.00	23.63	1,084.88
Axis Nifty Smallcap 50 Index Fund	14.09	46.67	21.67	169.11
ICICI Prudential Nifty Midcap 150 Index Fund	14.43	33.45	20.54	265.74
Aditya Birla Sun Life Nifty Smallcap 50 Index Fund	16.12	46.73	19.44	137.84
ICICI Prudential Nifty Smallcap 250 Index Fund	13.64	36.67	15.95	209.71
Motilal Oswal Nifty Midcap 100 ETF	47.28	37.35	14.99	373.28
ICICI Prudential S&P BSE Midcap Select ETF	135.17	28.91	14.20	38.65
Edelweiss NIFTY Large Mid Cap 250 Index Fund	13.06	22.70	14.18	77.21
DSP Nifty Midcap 150 Quality 50 Index Fund	11.78	17.66	12.98	194.50
UTI Nifty Midcap 150 Quality 50 Index Fund	11.48	17.72	8.66	162.86
DSP Nifty Midcap 150 Quality 50 ETF	200.05	18.40	7.54	78.65

Data Source: AMFI

The above table shows the performance of the small cap and mid-cap index funds available in India. These funds manage a small AUM of Rs8,787 crore. Over a 1 year period, the returns have ranged from 46.7% to 17.7% with median returns around 34%. This makes them among the best performing passive fund categories in India. If you look at these funds from inception, the returns range from 38.7% to 7.5% with median returns of around 26%. Much of the active fund flows are gravitating towards small cap funds and that is not surprising considering the alpha potential. It is just that the passive approach is not yet fully explored by investors. The Bandhan Nifty Smallcap 250 Index Fund in an opportunity to do just that.