Decoding India’s Small Caps: HDFC Small Cap Fund vs Nippon India Small Cap Fund
March 2, 2024 Mutual Fund
India’s burgeoning economy presents a wealth of investment opportunities, and small-cap mutual funds occupy a particularly intriguing niche. With the potential for rapid growth, these funds target companies possessing smaller market capitalisations but promising upside potential. These companies typically reside outside the top 250 listed stocks in India.
Before we dive into specifics, let’s understand the appeal of Small-cap funds:
- Growth Potential: Small-cap companies often possess higher growth potential compared to their large-cap counterparts. Being early in their lifecycle, they have larger avenues for expansion and market share capture.
- Undiscovered Gems: The small-cap space is generally less explored, which presents opportunities to uncover hidden gems – undervalued companies with significant upside prospects.
- Portfolio Diversification: Small-cap funds add a dynamic element to your portfolio, diversifying your holdings across different market segments.
However, investing in small-cap funds also comes with a set of considerations:
- Higher Risk: As smaller companies are more susceptible to market fluctuations, higher volatility characterises small-cap funds.
- Long-term Focus: Patience is key with small-cap investments. Their full potential may take several years to materialise.
- Careful Research: Selecting the right small-cap funds requires thorough analysis and market understanding.
[Read: Liquidity Check: Is Your Small Cap Fund Under Pressure?]
For those investing in Indian equities, the last couple of years have been wonderful. The year 2023 witnessed a phenomenal rally in the mid-cap and small-cap market in India, defying expectations and carving its niche in the financial landscape.
A surge in investments from domestic mutual funds specifically targeted mid-cap and small-cap stocks. Optimism surrounding India’s economic growth prospects, particularly after the COVID-19 recovery, led investors to seek opportunities in high-growth potential companies in the mid-cap and small-cap space.
Graph: Net Inflows in Small Cap Mutual Funds for the FY 2023-24
Data as of January 31, 2024
(Source: AMFI, data collated by PersonalFN)
In addition, relatively low interest rates throughout 2023 pushed investors towards equities, and the potential of higher returns in the mid-cap and small-cap segments compared to large-caps seemed attractive. The fascination of investors in India for small caps seems to be unending, and these are some of the key factors behind the inflows into Small Cap Mutual Funds.
[Read: Will Small Cap Mutual Funds Continue to Outshine in 2024?]
Two of the most prominent players in this small cap arena are the HDFC Small Cap Fund and the Nippon India Small Cap Fund. This article offers a comprehensive comparison of these two funds, aiding investors in making informed decisions.
HDFC Small Cap Fund is an open-ended equity scheme that belongs to HDFC Mutual Fund. It is a well-established small cap mutual fund scheme launched in April 2008 and currently has an AUM of Rs 28,606.62 crores (as of Jan 31, 2024).
The scheme’s longevity indicates stability and experience in the small-cap investment space. It’s known for its focus on identifying high-quality small-cap companies with strong fundamentals and significant growth potential. A seasoned team of fund managers with extensive experience in small-cap investing backs the fund.
HDFC Small Cap Fund is benchmarked against Nifty 50 – TRI as a primary index and S&P BSE 250 Small Cap – TRI as a secondary index.
# – Nippon India Small Cap Fund
Nippon India Small Cap Fund is an open-ended equity scheme and belongs to Nippon India Mutual Fund. It is a popular tax-saving scheme launched in September 2010 and currently holds an AUM of Rs 45,894.01 crores (as of Jan 31, 2024).
The scheme has carved a strong niche in the small-cap segment, and recent years have witnessed impressive track records, often placing the fund among the leaders in its category. It has a somewhat aggressive approach, focusing on identifying companies that demonstrate rapid growth potential. Nippon India Small Cap Fund is benchmarked against Nifty Smallcap250 – TRI as a primary index and S&P BSE Sensex – TRI as a secondary index.
Investment Style and Philosophy:
– HDFC Small Cap Fund primarily focuses on high-quality small-cap companies with growth potential and strong fundamentals. It adheres to a balanced approach, with a mix of established small-cap companies and emerging ones, ensuring some level of stability.
– Nippon India Small Cap Fund takes a more aggressive stance with a focus on rapid-growth companies. Despite its aggressive stance, the fund carefully considers the quality of its holdings, ensuring long-term sustainability. Its stock selection skews towards aggressive growth stories in smaller companies, seeking higher gains but with a potentially greater risk profile.
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Performance Comparison: Rolling Returns
Scheme Name Absolute (%) CAGR (%) 1 year 3 Years 5 Years 10 Years HDFC Small Cap Fund (G)-Direct Plan 36.97 27.25 15.41 21.33 Nippon India Small Cap Fund(G)-Direct Plan 35.19 33.47 18.34 28.54 Small Cap – Category Average 50.17 29.18 26.89 22.72 Benchmark – Nifty Smallcap 250 TRI 29.55 25.56 10.00 11.54 Data as of February 29, 2024
Do note past performance is not an indicator of future returns
The securities quoted are for illustration only and are not recommendatory.
(Source: ACE MF, data collated by PersonalFN Research)As we can see from the above table, both funds outperformed the benchmark (Nifty Smallcap 250 TRI) across all timeframes, demonstrating the ability of their fund managers to select stocks that delivered returns higher than the broader market.
Under the direction of Mr. Chirag Setalvad, who is renowned for his highly conviction long-term bets, the HDFC Small Cap Fund has performed admirably. The scheme has grown at a CAGR of 15.41% during the past five years. The goal of the HDFC Small Cap Fund is to reduce market risk over the long run by holding high-quality, fundamentally sound small-cap equities that are distributed across several industries in a well-diversified portfolio.
In recent years, Nippon India Small Cap Fund has witnessed impressive track records, often placing the fund among the leaders in its category and sometimes outperforming the HDFC small cap fund. In the last 5 years, Nippon India Small Cap Fund has grown at a CAGR of 18.34% compared to a growth of 10% in its benchmark Nifty Smallcap 250 – TRI.
However, it's crucial to remember that past performance is not always indicative of future results.
[Read: Can Small Cap Funds Deliver Big Returns Going Forward?]
Portfolio Composition: Asset Allocation of Schemes
Both HDFC Small Cap Fund and Nippon India Small Cap Fund are popular amongst investors in the small cap segment, but their asset allocation strategies differ slightly.
Scheme Name Small Cap % Large Cap % Mid Cap % HDFC Small Cap Fund 78.70 3.70 7.68 Nippon India Small Cap Fund 68.40 11.57 15.98 Data as of January 31, 2024
Do note past performance is not an indicator of future returns
The securities quoted are for illustration only and are not recommendatory.
(Source: ACE MF, data collated by PersonalFN Research)Both funds primarily invest in small-cap companies, as indicated by a higher allocation (78.70% for HDFC and 68.40% for Nippon). This aligns with the scheme's objective of seeking growth opportunities in smaller, emerging companies with high growth potential.
HDFC Small Cap Fund's portfolio is currently skewed towards the healthcare, automobile, banking and IT sectors. These sectors collectively account for 50% of the scheme's assets. The scheme usually restricts allocation in individual stocks to around 5%.
Surprisingly, Nippon India Small Cap Fund has a relatively higher exposure to large-caps (around 11%) compared to HDFC Small Cap Fund. This could serve as a buffer during market downturns or offer opportunities for investment in stable, established companies.
[Read: 5 Best Small Cap Funds for 2024]
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Market Volatility: Risk Profile of Schemes
The equity market experiences constant ups and downs, and small-cap funds are particularly susceptible to these fluctuations. Consequently, small-cap funds carry a higher risk profile compared to large-cap funds.
Risk Ratio (3 years) HDFC Small Cap Fund Nippon India Small Cap Fund Standard Deviation 16.73 16.98 Sharpe Ratio 0.49 0.53 Sortino Ratio 0.95 1.05 Data as of February 29, 2024
Do note past performance is not an indicator of future returns
The securities quoted are for illustration only and are not recommendatory.
(Source: ACE MF, data collated by PersonalFN Research)Both funds have almost similar Standard Deviations, exhibiting similar levels of volatility. An investment with high volatility is considered riskier than an investment with low volatility; the higher the Standard Deviation, the higher the risk.
The Sortino Ratio is similar to the Sharpe Ratio but focuses only on downside risk (excluding positive returns) to assess risk-adjusted returns.
Nippon India Small Cap Fund appears to offer a slight edge in terms of risk-adjusted returns based on marginally higher Sharpe and Sortino Ratios. This suggests that, historically, for the level of risk undertaken, Nippon India's small cap scheme has potentially delivered slightly better returns as compared to HDFC Small Cap Fund.
[Read: Want to Invest in Small cap Funds? Manage the Risk and Reward Well]
However, bear in mind this comparison is just to give you an idea about the risk profile of both schemes. One must consider their risk tolerance and investment goals to determine which fund aligns better with their investment strategy.
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Top Holdings of the Small Cap Schemes:
HDFC Small Cap Fund Nippon India Small Cap Fund Company % Assets Company % Assets Sonata Software Ltd. 5.00 Tube Investments of India Ltd. 2.78 Firstsource Solutions Ltd. 3.82 HDFC Bank Ltd. 1.64 Bank Of Baroda 3.71 Voltamp Transformers Ltd. 1.52 eClerx Services Ltd. 3.33 Apar Industries Ltd. 1.49 Aster DM Healthcare Ltd. 2.57 Multi Commodity Exchange Of India Ltd. 1.38 Power Mech Projects Ltd. 2.23 Karur Vysya Bank Ltd. 1.37 The Great Eastern Shipping Company Ltd. 2.22 Bharat Heavy Electricals Ltd. 1.24 Bajaj Electricals Ltd. 2.15 KPIT Technologies Ltd. 1.22 IDFC Ltd. 2.13 NIIT Learning Systems Ltd. 1.17 Equitas Small Finance Bank Ltd. 2.08 State Bank Of India 1.13 Data as of January 31, 2024
Do note past performance is not an indicator of future returns
The securities quoted are for illustration only and are not recommendatory.
(Source: ACE MF, data collated by PersonalFN Research)HDFC Small Cap Fund invests across various sectors, with top holdings spanning technology (Sonata Software), banking (Bank of Baroda), and other sectors. The scheme indicates a broader diversification and potentially lower risk profile compared to the Nippon.
Nippon India Small Cap Fund leans towards companies with high growth potential, which is evident in holdings like Tube Investments of India Ltd. and HDFC Bank Ltd. It emphasises a more concentrated approach and potentially higher risk-reward profile. The fund's focus on quality stocks and holding on to them with a long-term view has helped it outperform the benchmark and its peers.
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Expense Ratio of the Schemes
When comparing small cap funds, the Expense Ratio, which represents the annual fee charged, plays a crucial role in determining your returns. Here's a quick breakdown of HDFC Small Cap Fund vs Nippon India Small Cap Fund:
Scheme Name Direct Plan Expense Ratio Regular Plan Expense Ratio HDFC Small Cap Fund 0.61% 1.60% Nippon India Small Cap Fund 0.73% 1.51% Data as of January 31, 2024
Do note past performance is not an indicator of future returns
The securities quoted are for illustration only and are not recommendatory.
(Source: ACE MF, data collated by PersonalFN Research)HDFC Small Cap Fund offers a lower expense ratio in direct plan, indicating potentially higher net returns for investors compared to Nippon India Small Cap Fund. However, if one considers investing in a regular plan, Nippon India Small Cap Fund has a lower ratio.
While the Expense Ratio shouldn't be the sole decision factor, it's a vital aspect to consider, especially for long-term investments like small cap funds. Remember, a lower expense ratio translates to potentially higher returns over time.
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Suitability of Investors to the Schemes:
HDFC Small Cap Fund has a respectable track record of long-term success since it is managed by an experienced fund manager and is supported by a process-driven fund house. Investors were concerned about the fund's underperformance in 2015-16 and 2019-20, but the fund has recovered well in recent years and greatly enhanced its track record of overall performance.
[Read: Reasons That Should Not Be the Basis for Investing in Small-Cap Funds]
Nippon India Small Cap Fund has demonstrated exceptional performance over a long period of time, achieving success in all market phases. As a result, aggressive investors are starting to favour the scheme. The fund has generated returns that have outpaced the market and currently ranks in the top quartile of Small Cap Fund category performers over all time frames.
Both schemes are suitable for investors willing to accept higher potential volatility in exchange for higher potential returns. And the one's with a long-term investment horizon of at least 5-7 years or more. This allows you to ride out market volatility and potentially benefit from the compounded growth of small companies.
To summarise…
Both the HDFC Small Cap Fund and Nippon India Small Cap Fund offer investors a compelling way to tap into the potential growth opportunities within the small-cap segment of the Indian market. While they share broadly similar objectives, their distinct approaches and slight differences in risk-reward profiles make each suitable for slightly different investor types.
Ultimately, the choice between these funds depends on your individual risk tolerance, investment goals, and careful analysis of their portfolios and historical performance. Consulting a SEBI-registered financial advisor can be invaluable to ensure optimal alignment with your specific investment objectives.
This article first appeared on PersonalFN here
