First, the similarities. equity mutual funds and smallcases are both a portfolio of stocks. Both investment options can help you take exposure to the stock markets and build wealth over the long-term. In both cases, there is a team of expert analysts and researchers who do the hard work of picking stocks for you.
While equity funds have helped investors create wealth for years and years, they do have certain flaws. The idea of a smallcase came with the need to have an investment product devoid of these flaws.
We know that #MutualFundSahiHai, but now let’s see why #smallcasesBehtarHai.
Lower cost of investment
Equity funds have an annual expense ratio of 1% to 2.5%. The direct plans are much cheaper than the regular plans, so let’s assume an average expense ratio of 1.5%.
The expense ratio is the annual investment fee deducted from your investments in an equity fund. This is the cost you pay for investing in a fund. Let’s say you invest Rs 20,000 every month in an equity fund. In a year, you will invest Rs 2,40,000 and 1.5% of that is Rs 3,600. This is what you’re paying the equity fund as fund management fees and fees for other expenses. If you have invested in a regular plan, then the distributor’s commission will also be a part of the expense ratio. This expense ratio is automatically deducted from your investments.
In comparison, you only pay fees/brokerage when you place orders for a smallcase. This brokerage would depend on the broker with whom you have a demat account. You don’t pay smallcase any investment fee. Hence, investing in a smallcase is just a fraction of the expense ratio of an equity fund.
Flexible and transparent portfolio
An equity fund and a smallcase are both a portfolio of stocks that have been built by experts and research analysts. But the experts are not the only ones who know everything. You might have specific knowledge about a particular stock, because of which you might want to emit or add it to your portfolio.
An equity fund won’t allow you to do that. A smallcase will. When you invest in an equity fund, you have to compulsorily take exposure to all the stocks in the fund’s portfolio. But, a smallcase’s portfolio can be customised by you. Don’t like a stock? Remove it. Want to invest in one more stock? Add it. Want to increase exposure to a stock? Do it.
Not only is a smallcase’s portfolio this flexible, but it is also more transparent. An equity fund reveals its portfolio constituents only once a month, while a smallcase portfolio can be viewed anytime you want.
Always true to mandate
Every equity fund has an investment mandate. The mandate is a declaration of the type of stocks that the fund will invest in. For example, a large-cap fund will have the mandate to invest a majority of its assets in large-cap stocks. You invest in such a large-cap fund because you want a stable investment. But what if the large-cap fund suddenly starts increasing exposure to mid- and small-cap stocks? That would make the fund riskier, which is not what you wanted.
This shouldn’t happen, but it does because equity funds have to show outperformance in comparison to their peers. An equity fund can move away from its mandate in lieu of returns, but a smallcase won’t.
A smallcase doesn’t compete against other smallcases. Every smallcase is built on a theme, idea or model and stocks that don’t adhere to this mandate will not appear in the smallcase filters. What you opt for is always what you’ll get.
Ownership of shares
When you invest in a mutual fund, you get fund units. On the other hand, when you invest in a smallcase, you get shares in your demat account. This is a big plus because it allows you to earn dividend income. When a company declares dividend, it comes directly into the shareholder’s bank account and you don’t even have to pay tax on it.
Dividends from equity funds are not the same as dividends from stocks. Stock dividends are an additional income that you earn over and above the capital gains you make. Equity fund dividends are a part of your capital gains that are given out to you and are subject to a 10% dividend distribution tax. For example, if the current value of your fund investment is Rs 1 lakh and the fund gives you a dividend of Rs 2,000, then your investment value will go down to Rs 98,000.
Hence, equity fund dividends are not actual returns or additional profits. They are a part of your own investment only. But if your smallcase investment is worth Rs 1 lakh and a company within that smallcase declares dividend, then you will receive the dividend without it lowering your entire investment value. This truly becomes an additional income that you can earn thanks to direct ownership of shares.
When you place a redemption request with an equity mutual fund, the redemption is subject to the fund’s NAV at the end of that day. The redemption usually takes three working days to get processed.
On the other hand, a smallcase can be tracked in real-time during the market hours. The redemption requests are also placed in real-time because the shares you own can be sold while they are trading on the exchange. Adequate liquidity is one of the stock selection parameters used in smallcases, which facilitates quick redemptions.
In a smallcase, you can also pick and choose the shares that you want to sell. This is a more flexible way of exiting your investments partially.
High AUM doesn’t hurt investments
Often, equity funds pause fresh inflows from investors because their burgeoning assets makes it difficult to take nimble stock calls. This happens often in the case of mid-cap and small-cap funds, where their big AUM does not allow them to make impactful stock picks. Hence, a growing size can hurt an equity fund’s investment capabilities.
A smallcase has no such thing as an AUM of its own. When you invest in a smallcase, you get shares in your demat account. The money doesn’t stay in the smallcase and hence, AUM is never a factor that affects investment calls.
Easier to understand
NAV, expense ratio, AUM, growth option, dividend option, dividend reinvestment option, direct plan, regular plan, portfolio turnover, risk grade, return grade—this is just some of the jargon that comes with equity funds.
There are also many equity fund categories and a large number of options within each category to choose from. Not only are equity funds difficult to understand, but it is also very hard to figure out which fund to invest in.
In comparison, a smallcase comes with just the rationale, returns and stock weights. There are no different plans or options and no additional jargon to comprehend before you invest. All you have to do is understand the concept behind the smallcase to make an investment decision.
No cash holdings
It is often the case that equity mutual funds hold a substantial portion of their assets under management in cash. Historically, some equity funds have held even up to 15% in cash. There are two reasons why funds keep cash in their portfolio–to be ready for sudden redemptions and if the fund manager is unable to find investable opportunities.
In either case, cash holdings can hurt the performance of the equity fund. If the fund manager is not able to deploy the cash at the right time, the fund’s performance can get impacted.
However, a smallcase never has cash holding. Since a smallcase doesn’t have AUM of its own and the stocks are bought and sold at their market price, there is no requirement to hold cash. Hence, the negative impact of cash holdings in equity funds will not be seen on smallcases.
Aligning investments to ideas
Equity mutual funds allow you to invest in stocks by market capitalisation, investment approaches or sectors. You can invest in a large-cap fund or a value investing fund or an infrastructure fund. But equity investments should not be limited by market cap or sectors.
A smallcase allows you to invest in themes that are based on strong ideas. GST, affordable housing, electric mobility, etc are all ideas and themes that make a strong investment case. For example, the government’s focus on providing affordable housing to all will benefit companies that are fulfilling and enabling affordable housing projects. There’s a smallcase for that, but no equity fund.
A smallcase will allow you to invest in such themes or ideas, but there is no equity fund that will provide such exposure.
smallcases are built in a manner to optimise returns. A smallcase consists of no more than 20 stocks, which means that every stock has a meaningful impact on the portfolio’s returns.
The following table shows how the average smallcase returns have been way higher than the average equity fund returns over various time periods.
|1-year returns (%)||2-year returns (%)||3-year returns (%)||4-year returns (%)|
|Average of all smallcases||6.07||42.50||67.82||133.73|
|Average of all equity mutual funds||4.59||25.06||28.17||50.90|
|Total returns as on 5 July 2018|
As you can see, the numbers speak for themselves. Returns are primarily what we invest in equities for, and the higher the better.