January 24, 2019

NFO Note: Edelweiss Small Cap Fund
Our detailed analysis on the upcoming New Fund Offer (NFO) from Edelweiss Mutual Fund.

by iFAST Research Team

"Start with acorns, wind up with oak trees. Start with oak trees, and you won't have quite the same dramatic growth. That's small cap investing."

This famous quote from the book 100 Baggers: Stocks That Return 100-to-1 and How To Find Them by Christopher W. Mayer is how Edelweiss Mutual Fund pitches the Edelweiss Small Cap Fund NFO to their investors. The fund was launched on January 18, 2019 and the NFO will close on February 1. The fund will be managed by Harshad Patwardhan, CIO – Equities with the AMC, and a veteran of 25 years in the markets.

Investment Strategy

The Edelweiss Small Cap Fund's mandate allows it to invest into high quality small-cap companies that are compounding stories with reasonable growth prospects, have strong return ratios and are operating in niche environment. We had a freewheeling conversation with Patwardhan to understand the strategy and the timing of the launch. "There are certain very interesting growth opportunities that can be played only through small caps", he said explaining the impetus for the new fund. The focus of the fund in a nutshell will be to look at quality small caps that have shown strong earnings growth and have valuation upside – making them a good investment opportunity. He further elaborated with two examples:

• There are a few Indian chemical businesses that are expected to do well over the long term as they gain market share from China in select product categories. Here we are talking about 83% of the companies from the small cap segment accounting for 50% of the sector market capitalization.

• Staffing companies are growing fast and are expected to do well in the medium to long term. There is no large cap in this sector and two-thirds of the companies - both in terms of numbers and market cap - belong to the small cap space.

Portfolio Allocation Strategy



On being asked about the timing of the launch Patwardhan says, "You need to remember that out of the 870 stocks in the S&P BSE Small Cap Index, 210 are not covered by any analyst, while 398 are covered by less than 5 analysts. Moreover, the average number of analysts covering large caps is 30 while mid caps is 15. This means that the small caps are heavily under-researched and hence give us an opportunity to spot the businesses early on and generate alpha for our investors. In addition to this, we believe that the latest SEBI Categorization also gives us immense opportunities as the universe has shrunk for the large cap and mid cap funds, with the number of stocks available for selection being restricted to 100 and 150 respectively. In the small cap space, the universe is wide with 2500 stocks available for fund managers to choose from, and this, we believe, is the space to be in now."

He adds that the recent underperformance by small caps has been the worst ever in the last 12 years; but the agility they have shown to bounce back sharply leads to their out-performance vis-a-vis large cap funds over a long period. "It is high time that we scout for good opportunities in this space and hence this launch.", he ends.


STeP Facility: A first in the industry

Edelweiss Mutual Fund is not only clear about why they want to launch a small cap fund but also about how they want the investor surplus to be brought in to the fund. The STeP Facility is available only during the time of the NFO, and has no peers in the industry so far. It essentially enables investor money to be brought into the fund in 5 instalments, considering the fact that the next 6 months are going to be very volatile with the country going in for an uncertain election, along with not-so-stable macroeconomic parameters like crude prices, interest rates and more. At the time of application, only 20% of the investment will be immediately invested in the fund, while 80% of the surplus will be parked in the Edelweiss Liquid Fund. This surplus will be moved into the fund in 4 monthly instalments during market corrections. In case the trigger for correction does not hit during a month, then the stipulated amount will be moved out to the fund on the last business day of the month.


Our Take

Funds from Edelweiss Mutual fund have featured on our list of Recommended Funds for the first time this year. Our model has given a thumbs up to the mid cap fund, which is also managed by Patwardhan. His expertise in scouting stocks in the mid and small cap is an acknowledged fact even in the market.

At iFAST, we have always been firm believers in the funds from the small cap category and these funds have always been part of our moderately aggressive and aggressive portfolios. Despite the fact that they are highly volatile, our small cap bets have not disappointed our investors, if we look at a time horizon of 5 years and more. Of course, along with the opportunities available in the small cap space, a lot depends on the expertise of the Fund Management team in selecting stocks in this space and their conviction in the bets that they place, which is what finally creates alpha for investors.

We believe that team Patwardhan will be able to recreate the success of their midcap fund with their small cap outing. However, this fund is definitely not for the faint hearted and is strictly recommended for investors whose risk profile is moderately aggressive/aggressive and who have a time horizon of more than 5 years. Finally, we feel that investors should utilize the STeP Facility to enter the fund, considering not only the fact that we are in a volatile phase but also because we are talking about a very volatile category in the mutual fund space.


Happy Investing!!!




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