What is the fuss?

Investors keep at least one small cap mutual fund in their portfolio. Small Cap funds give high alpha (returns), vs other large cap or hybrid mutual funds. Choosing a small cap fund is tricky. Should you go for a fund giving the highest returns, or go with a fund with the lowest expense ratio?

I recently switched my small cap fund. I went with Tata Small Cap Fund. In this post I give my reasons for making this switch, to help you with some pointers to keep in mind while evaluating a small cap mutual fund.

Reason 1: Lower Expense Ratio

Expense ratio is the percentage of invested amount, charged as fees by the fund house. Tata Mutual Fund charges 0.25% as expense fees, whereas Axis Small Cap fund charges 0.53%.

Tata Small Cap fund costs 50% less than Axis Mutual Fund.

I like to pay less fees, without impacting my overall returns. Tata Mutual Fund wins in this bucket. Lower expense ratio does not necessarily means a compromise on the quality of services you get. In this case, Tata Small Cap fund provides more return than Axis Small Cap fund, covered in reason 4 below. Lower expense ratio can also result from efficient management of fund, less spend on marketing costs and other overheads etc.

Reason 2: Lower Assets Under Management (AUM)

AUM is the value of total assets (money) managed by the mutual fund scheme. Too low AUM is not desired, as it indicates that investors are not attracted towards the mutual fund scheme. On the other hand, too large AUM will make portfolio change decisions harder for the fund manager.

It is easy to buy and sell small value in the stock market. But as you start trading in large volumes, you may not get the price you want to buy at, or sell at.

The reason is, market price is decided by demand and supply of a stock’s share. If large volume buying happens, demand for the stock goes up, with limited supply. This increases the price of the stock. Therefore, if you buy in large volumes, you will get some shares at initial price, and then remaining shares at the new and higher market price.

Similarly, when you sell in large volumes, there is less demand and more supply of a share, pushing the price of the stock down. Thus, when selling in large volumes, you will get initial stock price for first lot of shares you sell. For the next lot of shares, you will be able to sell at reduced market price, and so on. You will end up selling at an overall less average price, than what the market showed before you started selling.

For these reasons, a medium size AUM fund is better for small caps, enabling easier portfolio changes.

Tata Small Cap Fund’s AUM (INR 3841 Crore) is 25% of Axis Small Cap Fund AUM (INR 12,257 Crore).

Reason 3: Concentrated Portfolio

Concentration refers to investing in less number of stocks. Concentration helps in maximising gains, as stock price appreciation in a concentrated stock will increase overall portfolio returns. As compared with a portfolio with hundreds of stocks, where even if one stock doubles, the impact on overall portfolio of this one stock will be negligible.

Having a concentrated portfolio is a personal preference. I like fund managers who have high concentration. This tells me that the fund manager is being picky, and chooses a small collection of stocks which he/she wants to bet on. I, personally, also do this while investing directly in stock. That is, I like being picky, and go with select stocks, rather than with lots of stocks.

As seen above, Tata Small Cap fund has 50 stocks, whereas Axis Small Cap fund has almost double (84 stocks).

Reason 4: Returns

‘Money Money, brighter than sunshine, sweeter than honey.’

All investors invest to generate the maximum returns possible. In the world of mutual funds, higher returns over long period of time (>3 years) is considered good.

On comparing Tata Small Cap fund with Axis Small Cap fund, we see that Tata Small Cap fund gives higher returns (47.2% CAGR) in last 3 years. Even though the difference is small, over long term compounding, even a 0.1% difference in annual CAGR returns can make a big difference,

Bonus Reason: Value Investing Style

I am a value investor. I like to go for mutual funds which follow a value investing style. I like buying low, and selling high. I am not a fan of buying expensive PE stocks.

In this regard, Tata Small Cap fund fares a little better than Axis Small Cap fund. Tata Small Cap fund’s portfolio’s PE is 22, which is lower than Axis Small Cap fund’s PE of 25.4. The Price to Book value, another indicator of valuation, is also 50% lower for Tata Small Cap fund, vs Axis Small Cap fund.

FAQ1: Why not invest in both Tata and Axis Small Cap fund?

This can be done. But I usually do not do it to avoid overlap of stocks in different mutual fund schemes of same category. Investing in a handful mutual fund schemes also saves me time — time spent on tracking and reviewing my investments.

Tata and Axis Small Cap fund, surprisingly, have less overlap.

I limit my mutual fund schemes to less than 5, and therefore only pick one mutual fund scheme form each category — MidCap, SmallCap, ELSS, and Thematic (IT & Tech sector).

FAQ2: Did I exit Axis Small Cap fund completely?

Not yet. I am still invested in Axis Small Cap fund. I will wait for 1 more year, to make my gains enter long term capital gains tax slab. Post that, I will re-compare Tata Small Cap and Axis Small Cap fund performance, and take final call on exiting Axis Small Cap fund.

Parting Thoughts

In my opinion, both the funds are good. They give good returns, double your money every 4 years. Tata Small Cap fund is a personal preference for me, basis my investing style.

You should pick mutual fund schemes basis your goals, investment style preference, and investment time horizon. You will hardly go wrong with reputed mutual fund house such as Tata, Kotak Securities, HDFC Securities, Mirae Asset, Canara Robeco, Parag parikh fund, or Axis Bank Mutual Funds.

Hope this helped you understand my reasons to switch to Tata Small Cap fund. Which small cap mutual fund are you invested in, and why? Share in the comments below.

Happy Investing!

Disclaimer: I am not a SEBI registered advisor. DYOR before investing. Do consider subscribing to my email newsletter here, to receive subscriber only info on Indian Stock Market.