In the past, small-cap stocks have faced various hurdles such as demonetization, mutual fund categorization, economic slowdown, etc. which led to the underperformance of the category. Now the second wave of COVID-19 and renewed lockdown restrictions pose a threat to its growth potential.

Though the small-cap stocks made a significant recovery from the last year’s low amid liquidity infusion, it remains to be seen if the earnings growth will be able to catch up to justify the current high valuations.

That said, market corrections can be seen as an opportunity for fresh investment in the small-cap space if you can stay invested for at least 7-10 years. When the economy recovers, small companies could report healthy growth on earnings and reward investors with superior returns. But, since only a few stocks in the small-cap space can be expected to show significant growth over the years, ensure that you invest in the segment only through a well-managed Small-cap fund.

Axis Small Cap Fund (ASCF) is a small-cap fund that has registered a clear trend of outperformance in the last few years without taking undue risk.

Graph 1: Growth of Rs 10,000 if invested in Axis Small Cap Fund 5 years ago

Data as on April 20, 2021
(Source: ACE MF)

Launched in November 2013 ASCF’s performance until 3 years ago had nothing to write home about. However, by focusing on high conviction and quality growth stocks along with the superior stock picking ability of the fund management, it has turned out to be the outperformer in the category. Notably, ASCF managed to efficiently limit the downside in the past two bear phases, while it also figured among the top performers in the previous bull phase. ASCF has established itself in the small-cap space within a short span of time and has caught the attraction of investors — it has shown massive growth in AUM from just about Rs 294 crore at the end of March 2019 to around Rs 4,485 crore at present. Over the last 5-year period, ASCF has generated returns at 18.4% CAGR, thereby outperforming the benchmark Nifty Smallcap 100 – TRI by a margin of around 8 percentage point CAGR.

Table: Axis Small Cap Fund’s performance vis-à-vis category peers

Scheme Name	Corpus (Cr.)	1 Year (%)	2 Year (%)	3 Year (%)	5 Year (%)	7 Year (%)	Std Dev	Sharpe
Quant Small Cap Fund	129	67.76	15.61	13.07	17.12	15.65	31.22	0.176
Axis Small Cap Fund	4,070	61.62	14.70	10.99	16.91	19.03	22.71	0.186
Kotak Small Cap Fund	2,894	90.23	17.03	9.39	13.28	14.16	27.92	0.148
SBI Small Cap Fund	7,145	90.23	17.03	9.39	13.28	14.16	25.29	0.118
Nippon India Small Cap Fund	11,721	94.01	22.17	9.70	19.43	24.33	28.69	0.097
Union Small Cap Fund	418	78.39	23.63	9.00	13.35	—	26.56	0.086
ICICI Pru Smallcap Fund	1,933	85.71	21.05	8.91	14.05	14.75	28.85	0.098
DSP Small Cap Fund	6,243	84.86	20.21	6.85	13.40	21.96	27.63	0.068
IDBI Small Cap Fund	114	74.16	15.73	6.24	—	—	25.63	0.055
HDFC Small Cap Fund	9,840	85.84	11.00	5.30	16.40	18.04	27.16	0.059
Nifty Smallcap 100 – TRI		100.00	11.67	0.39	10.60	12.08	33.59	0.034

Returns are point to point and in %, calculated using Direct Plan – Growth option. Those depicted over 1-Yr are compounded annualised.
Data as on April 20, 2021
(Source: ACE MF)

*Please note, this table only represents the best performing funds based solely on past returns and is NOT a recommendation. Mutual Fund investments are subject to market risks. Read all scheme related documents carefully. Past performance is not an indicator for future returns. The percentage returns shown are only for indicative purposes.

With spectacular performance in the last few years, ASCF has scripted an unbeatable track record of generating substantial alpha for its investors. The fund has outperformed its benchmark and category peers with a noticeable margin over the long term and has found place among the top performers in the small-cap fund category across various time frames. What makes ASCF far more attractive is its ability to generate superior returns even in conditions where most of its peers were challenged with limiting the downside.

Despite holding a high-risk investment mandate, ASCF has registered far lower volatility (standard deviation) when compared to its peers and the benchmark. The cautious investment approach followed at the fund house has helped ASCF deliver superior risk-adjusted returns for its investors. Its Sharpe ratio is commendable and among the highest in the category.

Investment strategy of Axis Small Cap Fund

ASCF is mandated to invest a minimum 65% of its assets in equity & equity related instruments of small cap companies, i.e. companies ranking 251st onwards on full market capitalisation basis. Accordingly, ASCF endeavours to invest primarily in high conviction small-cap stocks (around 65-70% of its assets). It also holds around 20-25% of its assets in mid-cap stocks.

The fund house employs a “Fair value” based research process to analyse the appreciation potential of each stock in its universe (fair value is a measure of the intrinsic worth of a company). The universe of stocks is carefully selected to include companies having robust business models and enjoying sustainable competitive advantages as compared to their competitors.

While building the portfolio, the fund management follows the bottom-up approach towards investing with a focus on the appreciation potential of individual stocks from a fundamental perspective. It seeks to identify long term businesses, keeping in mind risk and reward by containing mistakes and navigating volatile stock movements.

The fund house believes that the key to successful investing in small-cap stocks is patience and ability to withstand short term volatility. ASCF utilises a holistic risk management strategy, in order to manage risks associated with investing in equity markets.

Graph 2: Top portfolio holdings in Axis Small Cap Fund

Holding in (%) as on March 31, 2021
(Source: ACE MF)

ASCF is selective in its stock picks and invests in a fairly diversified portfolio of about 45-50 stocks. As on March 31, 2021, ASCF held 52 stocks spread across small and mid cap space. Among its top holdings the fund held names like Galaxy Surfactants, Tata Elxsi, Brigade Enterprise, Fine Organic Industries, and Can Fin Homes. The top 10 stocks in the portfolio together accounted for around 37.5% of its assets. The fund does not follow an over-diversification strategy and holds meaningful exposure in each of its holding.

In the last one year, ASCF has benefited majorly from its exposure to stocks like Tata Elxsi, JK Cement, and Galaxy Surfactants that turned out to be multi-baggers in the portfolio. Can Fin Homes, Coforge, Brigade Enterprise, JK Lakshmi Cement, Blue Star, Aarti Industries, etc. were among the major contributors to its performance.

Chemicals dominate ASCF’s portfolio with an allocation of around 17.2%. Financial services account for another 14% in the portfolio. The presence of Construction, Engineering, and Cement among the top sectors indicates that the fund manager is eyeing to benefit from economic recovery. The fund also holds significant exposure in Infotech, Consumption, Healthcare services, and so on.

Suitability

ASCF has been agile enough to take advantage of various investment opportunities present in the small-cap space as well as mid-cap segment. It aims to invest in high growth-oriented quality stocks available at attractive valuations and hold it with a long term view until the full potential is derived.

Despite being a growth-oriented small-cap fund of aggressive nature, ASCF does not resort to taking aggressive calls or momentum bets, instead it focuses on quality. This improves its chance of riding out tough market conditions. Even if the fund trails during an upside market trend, it can reward investors who choose to exercise patience.

The aggressive investment mandate along with higher allocation to mid and small caps makes ASCF suitable for investors having very high risk appetite and a long term investment horizon of at least 7-10 years.

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.

This article first appeared on PersonalFN here