The recent crash in smaller
companies' stocks has been traumatic for momentum chasers, but smarter
investors have done very well out of small cap funds
There's a course of shock therapy
that equity and equity fund investors have to go through every few years. The
stocks of small cap companies zoom up sharply for a time, and then they crash
down, again much more sharply than anything else. Sometimes this happens as an
amplified version of what's happening to the stocks of larger companies, and
sometimes by itself when the rest of the market is doing something else. The
first part brings great joy and happiness to investors,especially to those who
have forgotten the last such cycle, while the second part brings shock, and
hopefully, some learning about the risks inherent in small cap investing.
After a boom that lasted two years,
we now seem to be entering a phase when small cap stocks and the funds that
invest in them are heading down decisively. This was entirely to be expected,
and actually works to the advantage of investors in small cap funds. However,
there seem to be plenty of investors who are in shock and ready to head for the
exits.
To answer this question, investors
must consider what they expect from equity investing and whether they are
willing to put up with the risk and the volatility that is an inevitable part
of the same package that also contains great returns. Investment advisors and
analysts often ask investors to evaluate what kind of risks they are willing to
take in order to have a chance of getting the kind of returns that equity is
capable of. It's an open secret that in answering this question, most investors
lie to themselves, even if unwillingly.
When an investment is doing well,
it's natural to be full of bravado and be sure that you will take any
volatility in your stride because you understand the nature of equity and so on.
Equity investing seems like the easiest thing and the world, and those who talk
of risk and volatility appear to be nervous soft hearts. However, when the
markets start declining and the value of your investment starts going down
every day, then the answer to that question about risk-taking changes, as it
should.
So what should investors do? Should
they quit and run (perhaps switching their investment to large cap funds), or
should they stick it out? For some investors, if they feel they can't take the
volatility, the answer has to be that they should not invest in small-cap
funds. However, the right way to approach the whole thing is slightly
different. The first principle is also the oldest one, which is
diversification. Unless you have found that you enjoy the volatility, small cap
exposure not be more than 20 to 30 per cent of one's total equity assets.
However, the high returns that good
small cap funds generate are valuable. The way to exploit these properly is not
the momentum chasing of the recent past but steady SIP investing over long
periods of time. Those who understand the equation of SIP investing know that volatility is their
friend and the frequent drop in NAVs helps to generate higher returns in the
long run. Over the last five years, small cap funds SIP returns have typically
outpaced their own point-to-point returns by about 5 to 10 per cent per annum.
This is true not just of the better funds, but down the line as well. Over this
period, a high rated small cap fund (Franklin Smaller Companies) had lump sum
(one time investment) returns of 21.5 per cent p.a. while its SIP returns were
28 per cent. The interesting thing is that even a badly rated fund (HSBC
Midcap) had lump sum returns of 10.6 per cent p.a. and SIP returns of 21 per
cent p.a.!
And that is the real secret of small
cap investing, as it is of all equity investing. Stop chasing momentum and stop
worrying about volatility. Choose a fund with a decent track record--doesn't
have to be even close to the best--and then sustain it for years on end. You'll
do very well out of it.
No comments:
Post a Comment