Big Talk- S Naganath- DSP ML

BIG TALK: S. NAGANATH, PRESIDENT AND CIO, DSP MERRILL LYNCH FUND
MANAGERS

‘We will invest in smaller than small caps’

Sandeep Singh

Posted online: Monday , May 21, 2007 at 1225 IST
Updated: Wednesday, June 29, 2005 at 1257 hours IST -->

As the number of small-cap investment options increase, the definition of what is a small-cap stock — a market capitalisation of less than Rs 1,000 crore, Rs 3,000 crore or something else — is under scrutiny. In the absence of benchmarks, there is overlap among schemes, acknowledges S. Naganath, president and chief investment officer, DSP Merrill Lynch Fund Managers, whose Micro Cap Fund — a closed-end fund that will invest stocks ranked outside the top 300 by market cap — is currently seeking subscriptions. Naganath fielded questions from our correspondent on the new DSP fund, the risks and rewards of small-cap investing, and the loose market cap segmentation.

Your Micro Cap Fund is effectively a small-cap fund? Why not call it that — a small-cap fund?Our Micro Cap Fund is not a small-cap fund, as it will invest in companies smaller than small cap. By our definition, large caps are the top 100 companies by market capitalisation, mid caps are those from 101 to 200, small caps are the next 100 companies. Beyond the top 300 companies are micro caps, where the scheme will invest. We have tried to do the segmentation in such a way that our focus area is distinguishable from small caps.At present, many funds might be holding stocks from our target set, but their share in these portfolios is unlikely to exceed 10-12 per cent of the corpus. The Micro Cap Fund, by comparison, plans to invest at least 65 per cent of its corpus in such companies.
That’s your definition. On the BSE, the company ranked 300 by market value had a market cap of Rs 1,500 crore. In other words, you will be investing in companies with a market cap of less than Rs 1,500 crore. But many funds, even indices, term Rs 1,000-1,500 crore as small cap, even medium cap. How does an investor decide and compare?There is no single definition for market caps. There is overlap, as everyone has a different definition. In such a scenario, peer group comparison is tough and will remain so until market players draw up and accept a common classification.
The upper limit of the Micro Cap Fund is the market cap of the 300th most-valuable company, which is currently Rs 1,500 crore. What is the lower limit?There is no lower limit.
Even for the upper limit, you haven’t put a figure. It is linked to the market cap of the 300th most valuable company, which means it will keep changing.The market is dynamic and the market cap changes rapidly. If you peg the definition to absolute numbers, you are not moving with the market. The basis of ranking we have adopted is more in tune with the market’s dynamic nature. So, if the market cap of a company in our portfolio increases with the growing market, we will look at its rank, as against a case where the selection is on the basis of market cap in absolute terms.
What if a pick of yours appreciates smartly and enters the top 300. Will you sell that stock?We will follow our outlined objective of investing at least 65 per cent of the corpus in companies ranked below 300 by market cap. So, if we don’t have the legroom and if we feel the stock is not a pick, we will cut its weightage in our portfolio.
Coming to stock selection, there’s a volume of data available on large-cap stocks. What challenges do you face in the small-cap space and how do you go about stock selection?As far as the variables in the stock analysis goes, it will be more or less the same, but our research has to be a lot more efficient. We will pick companies on the basis of their industry, business fundamentals and financials. Challenges do exist. There will be fewer peer group comparatives for these companies. They might also be less liquid, though this risk will get mitigated because of the closed-end nature of our scheme. The closed-end structure gives us the chance to build a portfolio in a more gradual manner. I don’t see us churning the portfolio much.
The risk of failure is higher in small companies. What are the kind of checks and balances you adopt to minimise the risk of failure?We will monitor risk on a dynamic basis. The benefit of higher return will be there when these companies scale up due to rapid growth over five to 10 years. Some companies may not do well. In such cases, we will assess the situation and restructure our portfolio accordingly.
You will be picking companies you think will grow manifold. Can we then expect the Micro Cap Fund to beat the index benchmarks handsomely?Most equity diversified funds category have lagged benchmarks in the past year, but they have done very well over a three-year and five-year period. Our aim is to generate good long-term returns.
For an investor to truly reap the benefits of a small-cap fund, what should be their investment horizon?The higher, the better, but at least three years.
You have set the maximum corpus for the scheme at Rs 500 crore. Why?We are targeting Rs 500-600 crore and we won’t retain substantially more than that. We want to keep the scheme corpus at manageable levels and not let it become too big to manage. The excess money will be refunded and allotment will happen on first-cum-first serve basis.
Also, the minimum investment is Rs 10,000. Usually, the regular option varies from Rs 1,000-5,000. Why is that?We feel it is an appropriate amount and a comfortable one. Looking at current earning and spending patterns, it’s not huge.
There is also no dividend option in the scheme.We feel that investor who put their money in this scheme want growth. Therefore, we are offering only the growth plan.

http://www.expressmoney.in/news/We-will-invest-in-smaller-than-small-caps/86839.html