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WF: Your presentation makes an interesting point about the highest number of multibaggers in the last 5 years coming from the small caps space – as also the highest number of wealth destroyers. Given the sharp increase in institutional interest in small caps over the last 5 years and valuations not really cheap despite the correction, many experts believe that the quest for multibaggers in the small caps space is going to be hugely challenging. Do you share this view?

Mohan: Yes, mutlibaggers by definition are difficult to find. But as you can see from the presentation Small Cap Stocks are the most potential breeding ground for multibaggers. Investing in Small Caps can be a rewarding experience, provided the risks are managed well. We believe that Principal Asset Management with it’s experienced investment team, proven stock picking abilities, process driven research process and past track record of managing equity funds that had some exposure to small caps as well is well positioned to manage Small Cap Fund.

About the valuations I won’t worry too much about it as even though on index level valuations may not look very cheap but the universe of Small Cap is much larger than just Small Cap Index. Other than that Small Caps are about bottom-up stock picking and we believe that there is enough hunting ground for cherry picking stocks. A lot of good Small Cap stocks have corrected sharply last year and some of them are within our acceptable valuation range.

I would also like to highlight that returns may not match past performance of Small Cap category itself, but are attractively placed as compared with stocks with higher market capitalization

*Data Not Available as these companies were not listed on exchanges at the start period of this analysis
Data as on 31st Dec 2018. Source: AMFI; Bloomberg
Past performance may or may not be sustained in future

WF: Your presentation highlights the sharp pull back that has always accompanied previous small cap slumps and we are already witnessing a sharp recovery in March. What in your view, will help in sustaining the rally from here?

Mohan: Yes, historically we have seen that whenever Small Caps have corrected sharply they have bounced back also sharply in subsequent years.

The reason for our optimism is that overall investing environment in terms of expected improvement in economic growth going ahead and stable interest rates paint a positive picture

There may be a short-term volatility around elections, which actually may provide a reasonably good entry point for investors.

The market movement depends upon various factors hence it cannot be assumed that the correction is over. Investors are requested to note that the small cap performance is cyclical in nature. The above simulation is for illustration purpose only and should not be constructed as a promise on returns and safeguard of capital. This should not be constructed as a guarantee or forecasting of any returns.
Source: Bloomberg; Internal Analysis
Past performance may or may not be sustained in future

WF: Your presentation highlights at least 7 sectors that are much better represented in the small caps space compared to large caps. Which of these offer sound value today?

Mohan: Small Cap investing is about bottom up stock picking and the resultant sectoral allocation is matter of consequence rather than a design. But having said that, the point we are highlighting that there are certain sectors like chemicals are available in Small Caps and some of these sectors in general are well positioned to benefit from the economic environment. Some of the sectors wherein we currently find opportunities would be Chemicals, Soft commodities, EPC constructin companies, hotels and textiles to name a few

Data as on 28th Feb 2019. Source: www.nseindia.com

The sectors referred above should not be construed as recommendation from Principal Asset Management and/or Principal Mutual Fund. The scheme may or may not take any positions in these sectors. The views given above may change from time to time without any notice.

WF: What will be your investment and risk management strategy for investing in Small Cap stocks?

Mohan: The most important aspect of investing / risk management is to do in-depth research on the prospective companies by meeting the key management, understanding the business model, growth drivers, their challenges and converting the investment hypothesis into profit forecast for next 2-3 years. Once the forecast is done, then diligently monitoring the company to make the investing hypothesis is well on track.

To manage liquidity in the portfolio we follow certain guidelines in terms of liquidity of each company becoming a part of the portfolio and we may invest a certain portion in growth oriented mid and large caps for liquidity purposes without comprising on growth. We pay very high attention to development in Corporate Governance issues like promoters advancing loans to related parties, unrelated acquisitions or expansion into business lines and integrity of financial statements.

WF: One big mind set change in small cap company promoters over last few years seems to be a move towards higher standard of Corporate Governance. What is driving this trend?

Mohan:

• The entry of next generation in the business is also one of the drivers of this change
• With Small Caps catching the fancy of retail and institutional investors a lot of Small Cap promoters find it more profitable to follow proper Corporate Governance standards. Promoters have realised the win-win situation for minority shareholders and themselves by adhering to good corporate governance standards. As the potential reward of higher valuations in stock markets are good for both the promoters and minority shareholders. Over the last few years there are many examples of small caps becoming mid and large caps thereby generating huge wealth for the promoters as well as minority shareholders
• With increasing digitization and surveillance by regulators in India, it is becoming increasingly difficult for companies to indulge in accounting mal practices

WF: What used to be typical corporate governance issues in Small Caps and can you please share some of the steps being taken by managements to improve corporate governance standards?

Mohan: Some of the corporate governance issues revolved around advances loans to related parties, investing in non-core businesses, unreasonable remuneration to promoters and acquiring unrelated business.

Over the last few years we have observed

• Decrease in instances of advancing loans to related parties, invest in non-core business.
• Strong focus on ROCE/ ROE / Cash Flow Generation and reduction in leverage
• Appointing the Big 4 auditors to bring the best of the accounting practices.
• Declaring dividend policy

WF: What are the STEP facility and Auto Trigger facility that are offered along with this NFO?

Mohan: STEP Facility is a way to stagger the investments over 4 equal instalments to benefit from the averaging effect in case there is fall in the market. It also has a special feature that if the Scheme index goes down by 3% in any of the month, the instalment will be triggered without waiting for the month end. It is applicable only for the NFO Period.

Auto trigger is facility wherein the investor can choose to set a target return and as an when the target return is achieved, the appreciated value can move out to the scheme chosen by the investor

AUTO TRIGGER

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Disclaimers

The views expressed and information herein are independent views of the Fund Manager and for informative purpose only and under no circumstances should be construed as an opinion or Investment advice. The information contained herein is not intended to be an offer to seek solicitation for purchase or sale of any financial product or instrument. Investment involves risk. The investment strategy stated above may not be suitable for all investors and it may change from time to time without any notice and shall be in accordance with the strategy as mentioned in the Scheme Information Document of the scheme. Past performance may or may not be sustained in future.

Investors are requested to consult their investment advisor and arrive at an informed investment decision before making any investments. The Sponsor, Trustee, AMC, Mutual Fund, their directors, officers or their employees shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages arising out of the information contained in this document.

Mutual Funds investments are subject to market risks, read all scheme related documents carefully.

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