The U.S. Federal Reserve rocked the boat of global capital markets about six months ago by raising interest rates (to tame the inflation beast). We witnessed a selloff in the equity markets, and volatility intensified. With the yields moving up, global bonds have also reported a loss in market value. Major currencies, too, have come under pressure against the U.S. Dollar (USD).

Besides the geopolitical tensions are escalating: the Russia-Ukraine war doesn’t seem to be ending soon (on the contrary, Russia has put up a nuke threat now, which NATO observes, would prove devastating); fresh tensions have emerged in China-Taiwan relations; North Korea is provocative with nuclear activity build-up and missile launches; the gulf has its regional conflicts, and India, as you may know, has its border disputes at the Line of Actual Control (LAC) and the Line of Control (LOC).

Such a state of affairs does have repercussions on society, policy, and the global economy. The World Bank foresees the global economy slipping into a recession in 2023 and a string of financial crises in the emerging market and developing economies. If that indeed transpires, it would have a material impact on the business environment, corporate earnings, and consumer confidence. India would not be able to insulate or decouple, given the interlinkages today as regards global trade, commerce, and financial markets. As they say, when the U.S. sneezes, the world catches a cold. Thus, volatility will be inevitable!

Despite this, many investors are evaluating high-risk opportunities in search of high returns. Domestic investors — institutional and individuals — are taking advantage of the intermediate corrections in the Indian equity markets, and their net inflows have been resilient and positive.

In this article, we’ll elaborate on 5 high-risk equity mutual funds that may reward you handsomely over the long run.

Now you might be wondering what qualifies as a high-risk-high return investment proposition in the case of mutual funds. Well, typically mutual funds predominantly invest in smaller companies which have high growth potential.

Historically, the midcaps and smallcaps have exposed investors to greater risks, but when selection is done right, it has proved rewarding as well. Most of the exponential wealth-creation stories are from the midcap and smallcap segments.

In the Indian context, the first 100 companies on the market cap basis are classified as largecap, the next 150 are midcaps, and the rest are smallcaps. The stock count in the smallcap universe outnumbers that in the midcap and largecap space by far. And beyond the first 250 smallcap stocks, the rest are relatively lesser known and under-researched companies.

Therefore, whether you invest in smallcaps directly or through the equity mutual fund route, you need to be careful. It is important to choose mutual fund schemes evaluating a host of quantitative parameters (viz. returns, risk ratios, risk-adjusted returns, portfolio turnover, the expense ratio) and qualitative attributes (viz. Portfolio characteristics, i.e., the top-10 holdings, top-5 sectors, market-cap bias, the investment strategy, style of investing, as well as the credentials of the fund manager, his/her experience, the number of schemes he/she manages, the track record of the mutual fund schemes under his/her watch, and the overall efficiency of the mutual fund house in managing investors’ hard-earned money, among a host of other factors).

Graph 1: Smallcaps vs. Midcaps vs. the Nifty 100

Base: Rs 10,000
Data as of September 29, 2022
(Source: NSE, PersonalFN research) 

The graph exhibits how the midcap index has outperformed the largecap index on total returns, including the dividend payouts by its constituent stocks. The smallcap index, on the other hand, has underperformed midcap and largecap indices in the last 5 years.

Graph 2: Valuations in the smallcap and midcap space

Data as of September 29, 2022
(Source: NSE, PersonalFN research) 

Currently, on valuations, measured by Price-to-Earnings (P/E) ratio, across the market capitalisation segments, we have dropped noticeably since the peak, thus offering a reasonable margin of safety provided the investment horizon is at least around 5 years. With exposure to schemes with worthy portfolio characteristics, you could potentially clock an appealing return over the long run.

At PersonalFN, we evaluated 28 midcap schemes and 24 smallcap schemes to identify the ones that may qualify as high-risk-high-return propositions. Note, we excluded schemes that are yet to complete 3 years, and then evaluated the risk-adjusted returns of the remaining ones for the final tally; consisting of 3 smallcap schemes and 2 midcap schemes.

Keep in mind, the schemes mentioned herein are in no way direct mutual fund recommendations and, therefore, should not be treated as such. It is suggested that you speak to your investment advisor for further assistance before investing.

Table 1: 5 high-risk-high-return smallcap and midcap funds

Scheme Name Return (Absolute %) Return (CAGR %) Risk-Ratios
1 Year 2 Years 3 Years 5 Years 7 Years SD Annualised Sharpe
Quant Small Cap Fund 4.1 50.6 49.9 21.9 17.8 32.34 0.40
Bank of India Small Cap Fund 8.1 42.2 40.1 24.75 0.41
Canara Rob Small Cap Fund 12.9 46.4 39.1 25.61 0.40
PGIM India Midcap Opp Fund 6.0 42.1 38.6 20.8 18.2 24.24 0.41
Quant Mid Cap Fund 15.8 45.2 36.8 21.5 17.7 24.42 0.38
Category average-midcap 3.5 33.1 24.2 14.2 15.2 21.63 0.23
Category average-smallcap 5.8 40.6 31.0 15.4 17.0 26.03 0.31
Nifty Midcap 150 – TRI 2.7 34.5 25.3 14.0 16.4 25.88 0.27
Nifty Smallcap 250 – TRI -1.5 35.9 25.4 9.3 12.7 30.51 0.25

Direct Plan and Growth Option considered.
Past performance is not indicative of future returns. Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
Speak to your investment advisor for further assistance before investing.
Data as of September 29, 2022
(Source: ACE MF, PersonalFN research) 

The above schemes have generated a noticeable alpha, i.e., outperformed the Nifty Midcap 150-TRI and the Nifty Smallcap 250-TRI over 3-yr and 5-yr periods by a significant margin and exhibited an above-average performance.

#1: Quant Small Cap Fund

Launched in October 1996, Quant Small Cap Fund aims to generate capital appreciation and provide long-term growth opportunities by investing in a portfolio of smallcap companies.

As of August 31, 2022, Quant Small Cap Fund held 58 stocks in its portfolio, with top-10 stocks contributing 42.2% to the tally. The fund largely remained invested, and its equity component accounted for 99.3% of its portfolio. Smallcaps had a 71.9% weightage in the portfolio, while midcaps and largecaps accounted for 7.6% and 19.8%, respectively.

Table 2: Top-10 holdings of Quant Small Cap Fund

Stocks % of Assets
ITC Ltd. 9.5
IRB Infrastructure Developers Ltd. 6.3
Ambuja Cements Ltd. 5.9
Hindustan Copper Ltd. 3.8
The India Cements Ltd. 3.3
HFCL Ltd. 3.3
Arvind Ltd. 2.7
Linde India Ltd. 2.6
Patanjali Foods Ltd. 2.5
RBL Bank Ltd. 2.4

Data as of August 31, 2022
(Source: ACE MF, PersonalFN research) 

Interestingly, despite being a small cap fund, ITC, which is a bluechip stock, has been the fund’s largest holding. Over the last 1 year, the fund has gradually increased its investment in the company and has benefited immensely from its re-rating. This shows the fund house has adopted a flexible approach to create alpha.

The fund hasn’t shied away from churning its portfolio based on its multi-disciplinary stock selection framework. A few contra bets of the fund in telecom, metals and capital goods have worked remarkably well over the past few years.

#2: Bank of India Small Cap Fund

Launched in December 2018, the Bank of India Small Cap Fund aims to provide investors with opportunities for long-term capital appreciation by investing predominantly in equity and equity-related instruments of Small Cap Companies.

As of August 31, 2022, the fund held 63 stocks, with top-10 holdings accounting for 25.4% of the portfolio, making it well-diversified. The fund has held 95.4% in equities and the remainder mostly in cash & cash equivalents. None of its equity holdings is more than 5% of the portfolio individually. The allocation to smallcaps has been comprised of 69.2%, in midcaps 20.5%, and 5.7% in largecaps.

Table 3: Top-10 holdings of Bank of India Small Cap Fund

Stocks % of Assets
ICICI Bank Ltd. 3.6
Timken India Ltd. 3.5
City Union Bank Ltd. 2.8
Home First Finance Company India Ltd. 2.6
The Phoenix Mills Ltd. 2.3
K.P.R. Mill Ltd. 2.3
Rolex Rings Ltd 2.1
Ratnamani Metals & Tubes Ltd. 2.1
SKF India Ltd. 2.1
JB Chemicals & Pharmaceuticals Ltd. 2.0

Data as of August 31, 2022
(Source: ACE MF, PersonalFN research) 

The fund, by and large, has largely followed a buy-and-hold strategy but, at times, not refrained from churning. The fund has been sector agnostic in its approach. The fund’s investments in autos and auto ancillaries have rewarded investors over the last 12-14 months.

# 3: Canara Robeco Small Cap Fund

Launched in February 2019, Canara Robeco Small Cap Fund aims to generate capital appreciation by investing predominantly in smallcap stocks. As of August 31, 2022, the fund held a well-diversified portfolio of 71 stocks consisting of 67% smallcaps, 21% midcaps and 7% largecaps. Top-10 stocks accounted for 22.9% of the fund’s portfolio.

Table 4: Top-10 holdings of Canara Robeco Small Cap Fund

Stocks % of Assets
City Union Bank Ltd. 3.0
Schaeffler India Ltd. 3.0
Can Fin Homes Ltd. 2.6
Grindwell Norton Ltd. 2.2
Cera Sanitaryware Ltd. 2.2
Century Textiles & Industries Ltd. 2.1
CreditAccess Grameen Ltd. 1.9
Mahindra Lifespace Developers Ltd. 1.9
The Great Eastern Shipping Company Ltd. 1.9
Timken India Ltd. 1.9

Data as of August 31, 2022
(Source: ACE MF, PersonalFN research) 

Canara Robeco Small Cap Fund has historically adopted a conservative approach and largely followed the combination of top-down and bottom-up stock picking. The fund’s buy-and-hold strategy has rewarded its investors well over the last 2-3 years.

The fund’s sectoral preferences are broadly in line with the market trends and sector rotations. This is evident from its recent portfolio choices too. In recent times, it has increased the exposure to hotels and restaurants, financials, autos and capital goods companies. The fund has usually refrained from taking contra-investing calls and has adequately compensated its investors.

#4: PGIM India Midcap Opportunities Fund

Launched in December 2013, PGIM India Midcap Opportunities Fund aims to achieve long-term capital appreciation by predominantly investing in equity and equity-related instruments of midcap companies.

As of August 31, 2022, the fund held 94% of its assets in equity while the balance was cash & cash-equivalents maintained to manage the liquidity requirements of the portfolio. The fund held 48 stocks, with top-10 stocks occupying around 35% of the portfolio weight. The weightage of midcaps was 67%, while smallcaps and largecaps accounted for 18% and 9%, respectively.

Table 5: Top-10 holdings of PGIM India Midcap Opportunities Fund

Stocks % of Assets
ABB India Ltd. 4.4
TVS Motor Company Ltd. 4.1
Timken India Ltd. 3.9
The Indian Hotels Company Ltd. 3.7
Varun Beverages Ltd. 3.6
HDFC Bank Ltd. 3.3
Laurus Labs Ltd. 3.3
Crompton Greaves Consumer Electricals Ltd. 3.2
Dalmia Bharat Ltd. 3.0
Jubilant FoodWorks Ltd. 2.9

Data as of August 31, 2022
(Source: ACE MF, PersonalFN research) 

PGIM India Midcap Opportunities follows the combination of top-down and bottom-up approaches for stock selection.

Looking at its portfolio preferences, it seems the fund doesn’t believe in taking concentrated conviction bets but plays broader market themes through adequate diversification and prudent portfolio rebalancing. For instance, over the last one year, the fund has pared its exposure to midcap healthcare and IT stocks and has been buying selectively into consumer discretionary companies.

#5: Quant Mid Cap Fund

Launched in February 2001, Quant Mid Cap Fund aims to generate capital appreciation and provide long-term growth opportunities by investing in a portfolio of Mid Cap companies.

As of August 31, 2022, the fund remained largely invested and allocated 99.2% of its corpus to equity assets. It held the remaining 0.8% in cash and cash equivalents to deal with liquidity requirements. The fund held a compact portfolio of 30 stocks, wherein the midcaps formed around 75% of the portfolio, smallcaps accounted for less than 2%, and the remainder are largecaps.

Table 6: Top-10 holdings of Quant Mid Cap Fund

Stocks % of Assets
Container Corporation Of India Ltd. 7.6
Escorts Kubota Ltd. 7.5
Patanjali Foods Ltd. 7.5
Oracle Financial Services Software Ltd. 6.8
Ashok Leyland Ltd. 6.8
The Indian Hotels Company Ltd. 6.0
Tata Communications Ltd. 5.0
Adani Ports and Special Economic Zone Ltd. 4.7
NTPC Ltd. 4.2
Ambuja Cements Ltd. 3.8

Data as of August 31, 2022
(Source: ACE MF, PersonalFN research) 

The fund’s top-10 holdings occupied around 60% of the fund’s portfolio, suggesting that the fund house doesn’t shy away from following its conviction.

Like most other schemes from Quant Mutual Fund‘s stable, Quant Mid Cap Fund also churns its portfolio, relying on its multi-disciplinary stock selection framework. The fund has benefited immensely from its flexible approach to both value and growth stocks. On numerous occasions, its contra calls have worked favourably–be it getting rid of IT (when the sector looked overvalued yet remained the favourite of others in the market) or adding under-owned FMCG names.

Quant Mid Cap appears to be one of the only few schemes that have managed to capitalise on stellar rallies in the Adani group companies.

Who should invest in high-risk mutual fund schemes with a high-return potential?

If you have a very high-risk appetite and a time horizon of at least 5 years, the smallcap funds and aggressive midcap funds may be considered. That said, you ought to be mindful of your risk profile and the type of financial goals you are addressing and stick to your personalised asset allocation.

This article first appeared on PersonalFN here

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