Small Cap needs definition

MFs want uniform definition of ‘small’ in small cap firms

Sandeep Singh
Posted online: Tuesday, May 22, 2007

Mutual Funds: The word small stretches from Rs 10 crore to Rs 6,000 crore
New Delhi, May 21: If there’s one common theme binding small investors, small companies and funds launching small cap funds for small investors, it is: ambiguity. Coming up for debate is definition of “small cap”, a company whose market capitalisation is, well, small. But that “small” value could range between Rs 10 crore to over Rs 6,000 crore. At stake: investor expectations.

“In the absence of a clear classification accepted uniformly across the industry, there are as many definitions as there are small-cap schemes and indices. Says T P Raman, managing director of Sundaram BNP Paribas Mutual Fund: “We need to organise a meeting or seminar of fund houses, Sebi, NSE and AMFI officials, define a proper classification and monitor it every three to six months, as the size of companies is changing fast.”
At present, there are two dedicated small-cap funds — Sundaram BNP Paribas Select Small Cap and DSP Merrill Lynch Micro Cap Fund — and one portfolio management scheme — Kotak Origin of Kotak Securities. In the Sundaram scheme, small cap is defined as companies other than the top 100 NSE companies ranked by market capitalisation. As on Friday, that meant companies whose market cap was less than Rs 6,138 crore.
DSP Merrill Lynch, however, defines small cap as NSE companies ranked 201-300 by market cap, implying a market capitalisation of Rs 1,441-2,541 crore. So it is targeting companies ranked between 200 and 300.
“There is an overlap because everyone has his own definition. This will exist till market players draw up and accept a common classification,” says S Naganath, president and chief investment officer of DSP Merrill Lynch Mutual Fund.
Ironically, neither scheme is aligned to the definition of the benchmark they track — the BSE Small Cap Index, which as of May 18 had 508 stocks. On that day, the market cap of 507 of these stocks ranged from Rs 10 crore to Rs 3,216 crore; stock number 508 was Cairn India, with a market cap of Rs 25,473 crore.
Meanwhile, funds continue to devise their own definitions and target sets (See table).
For investors, multiple definitions mean they have to check the target stock set of the fund they are considering investing in and difficulty in comparing returns. Says Raman: “Comparison will be tough, as different funds will have companies from different market capitalisation sets.”
Why go small
Investors are attracted to small caps because potentially they can deliver higher than market returns, as smaller companies due to their smaller base can grow faster. The returns come in multiples as companies like Pantaloon (44-fold growth in five years) and Unitech (723 times) have shown. Mid- to large-sized companies like Aban Offshore (134 times), Areva T&D (62 times), Sesa Goa (54 times) and so on were all small caps five years ago. Such companies also carry a much higher risk, as the potential to fail or go bankrupt is equally high. Besides, it is not easy to sell such stocks when the going gets tough.
Finally, since small companies don’t fit into institutional investors’ portfolio and hence are not tracked by analysts, getting information about them is difficult, making the investing exercise that much more difficult — most “vanishing companies” come from this breed.

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