Nippon India Small Cap Fund: Offering Diversification in Small-sized Companies

Nippon India Small Cap Fund is the largest scheme in the Small Cap Fund category that has a solid track record of generating significant alpha and has constantly figured among the top quartile performers.

Past performance is not an indicator of future returns
Data as on December 07, 2022
(Source: ACE MF)

Nippon India Small Cap Fund has been able to capitalise on the sharp run-up in the small-cap space seen in the last couple of years, which has helped it fix a spot among the top quartile performers in its category across time frames. In the last 1-year, 2-year, and 3-year periods, Nippon India Small Cap Fund has outperformed the benchmark Nifty Smallcap 250 - TRI by a margin of around 9-13 percentage points and outpaced most of its peers by a broad margin. Even over the longer time period of 5 years and 7 years, the fund has managed to generate a substantial lead over the benchmark and the category average.

Consequently, Nippon India Small Cap Fund stands out in terms of risk-adjusted returns. Even though its volatility, as denoted by the Standard Deviation, is slightly higher than the category average, it is much lower than the benchmark. Moreover, its Sharpe ratio (0.32) is currently among the best in the category and far ahead of the benchmark.

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Investment strategy of Nippon India Small Cap Fund

Categorised as a Small Cap Fund, Nippon India Small Cap Fund is mandated to invest a minimum of 65% of its assets in equity and equity-related instruments of small-cap companies. SEBI defines small-cap stocks as companies ranking 251st onwards in terms of full market capitalisation. Nippon India Small Cap Fund aims to build a portfolio that adequately reflects a cross-section of the growth areas of the economy from time to time. The scheme's investment philosophy focuses on investing in companies with long-term growth potential available at reasonable valuations. It looks to identify high-growth businesses with reasonable size, quality management, and rational valuation.

The fund manager adopts risk management measures such as margin of safety and diversification across sectors and stocks with an aim to generate relatively better risk-adjusted returns over a period of time. Nippon India Small Cap Fund holds a large portfolio of around 150 stocks to benefit from an optimal mix of growth, economic revival, value, and thematic plays. The fund also allocates a significant portion of its portfolio in stocks of large-cap and mid-cap companies depending on market conditions to minimise the high risk associated with small-cap stocks. Nippon India Small Cap Fund follows a buy-and-hold strategy for most of its stock holdings and has recorded a low turnover rate of 25-30% in the last one year.

Nippon India Small Cap Fund holds a large number of stocks in the portfolio and limits the exposure to individual stocks to well under 5% in order to reduce the high downside risk associated with small-sized companies. As of November 30, 2022, the fund held 161 stocks in the portfolio, with the top 10 stocks accounting for just 18.3% of its assets. Small-cap names such as KPIT Technologies, Tejas Networks, Fine Organic Industries, Balrampur Chini Mills, and Timken India currently form part of the fund's top 10 holding, along with a few large-cap and mid-cap names such as Tube Investments of India, HDFC Bank, Bank of Baroda, Poonawalla Fincorp, and Navin Flourine International.

In the last one year, the fund has benefited the most from its holdings in Tube Investments of India, KPIT Technologies, Poonawalla Fincorp, Fine Organic Industries, West Coast Paper Mills, Bank of Baroda, Fineotex Chemicals, CreditAccess Grameen, Timken India, and Tejas Networks, among many others.

Nippon India Small Cap Fund's portfolio is well-diversified across Cyclical and Defensive sectors. The fund's portfolio is currently skewed towards the Engineering sector, closely followed by Financials. These sectors collectively account for 38.4% of Nippon India Small Cap Fund's assets. It also holds substantial exposure to Infotech, Consumer Durables, Consumption, and Chemicals having allocation in the range of 7-9%. The top 5 sectors account for 54.8% of its assets.

Suitability

Nippon India Small Cap Fund has generated superior returns since its inception. The fund's focus on investing in a range of stocks available at a reasonable margin of safety has helped it minimise the downside risk during bearish market phases. Meanwhile, the focus on fundamentally sound stocks having high potential stocks and holding them with a long-term view has enabled it to do well during upside markets.

Having an aggressive investment mandate with substantial exposure to small-cap and mid-cap stocks, Nippon India Small Cap Fund is susceptible to high volatility in the mid and small-cap space. Despite this, the fund has generated superior risk-adjusted returns, thereby rewarding investors with a noteworthy premium for the level of risk taken.

Nippon India Small Cap Fund is suitable for aggressive investors looking for a well-diversified Small Cap Fund with a high return potential over a long-term investment horizon of at least 5-7 years.

Warm Regards,
Divya Grover
Research Analyst

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Note:  This write up is for information purpose and does not constitute any kind of investment advice or a recommendation to Buy / Hold / Sell a fund. Returns mentioned herein are in no way a guarantee or promise of future returns. As an investor, you need to pick the right fund to meet your financial goals. If you are not sure about your risk appetite, do consult your investment consultant/advisor. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.

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