All you need to know about new DSP Nifty Smallcap250 Quality 50 Index Fund

DSP Mutual Fund on Tuesday launched a small-cap Index Fund.

The DSP Nifty Smallcap250 Quality 50 Index Fund is an open-ended scheme designed to track 50 selected stocks from the Nifty Smallcap 250 universe, which comprises 250 stocks.

The Nifty Small Cap 250 Index is a stock market index that tracks the performance of small-cap companies listed on the National Stock Exchange of India (NSE). It is a subset of the broader Nifty index, which tracks the performance of the top 50 companies listed on the NSE. As the name suggests, this index invests in Nifty Smallcap 250 companies, or the top small-cap companies which have a market capitalization between Rs. 250 crore and Rs. 5000 crore.

 

The Quality 50 Index, as per the AMC, employs exclusion and stock selection criteria based on factors such as return on equity (RoE), debt to equity, and earnings per share. It filters out companies from the Nifty Smallcap 250 universe, ultimately selecting 50 stocks with higher RoE and lower leverage than the broader Nifty Smallcap 250 Index.

The new fund offering has been open for subscription since December 5, 2023, and will close on December 15, 2023. The fund managers of the scheme are Anil Ghelani and Diipesh Shah.

Asset allocation strategy 

Under normal conditions, the scheme's asset allocation is expected to range between 95 per cent and 100 per cent in equity and equity-related securities of companies forming the Nifty Smallcap250 Quality 50 Index, classified under a very high-risk profile. Additionally, a minimum of 0 per cent and a maximum of 5 per cent allocation will be directed towards cash and cash equivalents, representing a low to medium-risk profile.

 

Nifty Smallcap250 Quality 50 TRI

According to the AMC, companies in the small-cap space have the potential to deliver a larger return on investment than large-cap companies. However, they also have the potential to fall more than large caps from their peaks.

 

Small caps also have a higher number of multi-baggers compared to large and mid caps, but they also have a higher number of stocks with negative long-term returns. 

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Multi-bagger refers to a stock or investment that experiences a substantial increase in value, typically many times its original investment cost. 

“Our passive offering aims to reduce the risk of capital loss by choosing ‘Quality’ companies with better fundamentals with an aim to keep wealth destroyers away to a great extent,” says Anil Ghelani, CFA, Head – Passive Investments & Products, DSP Mutual Fund.  

The Quality Index chooses the small-cap companies that are fundamentally sound for a better return on their investment. They have outperformed its parent broader Index since its inception. In 12 out of 19 calendar years – the Quality Index performed better than the broader Index. 

 

In fact, on a 10-year basis, the Quality Index has always outperformed the broader index and active small-cap funds. The Quality Index have companies that have higher RoE and lower leverage compared to the broader Index.

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The Quality Index has shown a lower downturn compared to the broader index.  It also recovers faster as drawdowns are lower. Notably, it took around 6.4 years for the broader index to cross its highest peak made in January 2008 while for the quality index, it took only 2.5 years. 

 

Mutual fund recommends SIP route for investment 

The AMC has advised to consider opting for the scheme through the SIP (Systematic Investment Plan) route. 

According to the AMC, the 10-year SIP returns have demonstrated that long-term SIP investments in the Quality Index yield similar returns regardless of whether the market is at its peak or in a downturn, outperforming the broader Index significantly. 

 

Notably, during specific periods such as December 10, 2007, to November 10, 2010, November 10, 2010, to May 19, 2014, and January 15, 2018, to March 16, 2021, when lump-sum investments in the broader index yielded 0 per cent returns, SIP returns in the broader Index ranged from 18 per cent to 41 per cent, said the firm. In contrast, SIP returns in the Quality Index during the same periods would have been between 20 per cent and 52 per cent, it said.

As per the AMC, starting a SIP at market highs nudges better behaviour by adjusting return expectations. Acquiring initial units at higher prices encourages long-term commitment. This approach benefits from accumulating more units during market declines and capitalising on rising NAVs during market upswings. 

Long-term SIPs in the Quality Index consistently outperform the broader Index, offering similar returns regardless of market conditions, said DSP MF. 

What are the Quality stock filters? 

The AMC employs three key stock selection criteria to identify 50 quality stocks:

1. Return on Equity (RoE): This metric gauges a company's financial performance by assessing its capital utilization efficiency. A rising R0E signals a company's ability to generate higher profits without requiring significant capital investment.

2. Debt to Equity Ratio: This indicator measures financial leverage. Higher leverage may entail increased fixed costs and greater vulnerability to bankruptcy. However, it is not applied to financial services companies.

3. Earnings Per Share (EPS) Growth Variability: Reflecting the earnings quality of a company, consistent EPS growth indicates robust and sustainable earnings. Conversely, companies with negative EPS are not considered in the selection process.

Remarkably, among the top 10 holdings of Nifty Smallcap 250 TRI, only two holdings overlap with those of Nifty Smallcap 250 Quality 50 TRI: Central Depository Services India and KEI Industries Ltd.

 

The Quality 50 Index has no exposure to the media, real estate and energy sectors. It is also underweight on industrials, financials and consumer discretionary while overweight in materials, IT, and consumer staples. 

Why opt for the DSP Nifty Smallcap250 Quality 50 Index Fund

According to the AMC investing in 50 quality small-cap companies, the fund focuses on higher profitability, lower leverage, and stable earnings.

1. The fund ensures diversification beyond banks, emphasising a broader investment approach.
2. Over 10 years, the Nifty Smallcap250 Quality 50 Index has consistently outperformed both the Nifty Smallcap250 TRI and the average of Active small-cap funds.
3. In 12 out of 19 calendar years, the Nifty Smallcap250 Quality 50 TRI has outperformed its parent index, Nifty Smallcap250 TRI, with an earned CAGR of 19.3 per cent compared to 15.7 per cent by Nifty Smallcap250 TRI over the last 19 years.
4. Positioned for a potential comeback, the fund follows a 'zero-bias' strategy as a passive fund, avoiding fund manager bias and maintaining a comparatively lower expense ratio than active small-cap funds.

Risk factors to consider

Here are the key risks associated with the fund, as per the AMC: 

1. Nifty Smallcap 250 TRI comprises 250 stocks, offering a diversified universe, whereas Nifty Smallcap 250 Quality 50 TRI is more concentrated with 50 stocks.
2. Certain sectors with high leverage, such as telecom and power, are not significant in the Nifty Smallcap 250 Quality 50 Index, potentially leading to underperformance when these excluded sectors perform well.
3. Historically, there have been periods of short-term underperformance by Nifty Smallcap 250 Quality 50 TRI compared to Nifty Smallcap 250 TRI.
4. Active small-cap funds, investing a minimum of 65 per cent in small-cap stocks with flexibility in large-caps and mid-caps, may outperform Nifty Smallcap 250 Quality 50 TRI due to their unique stock selection frameworks and philosophies.
5. Investing in small-cap companies assumes their ability to grow earnings rapidly, but there is a risk of unmet expectations or unforeseen market changes that could adversely affect results. 

According to the risk-o-meter, the principal invested in the scheme carries a 'very high' risk. 

The minimum application amount, applicable to both Regular and Direct Plans for fresh purchases and additional purchases, is Rs 100, with the same for the minimum instalment for the SIP.