Correct sector identification plays a vital role in small‐cap investing. Fund managers of small‐cap funds in India explore opportunities to identify industries with higher potential returns.
While the investment landscape has always been dynamic and subject to change swiftly, three sectors viz Specialty Chemicals, Consumer Durables, and Building Material, where small cap fund managers had healthy allocations in the last 2‐3 years, have successfully outperformed other industries.
A mix of top‐down and bottom‐up approaches followed by fund managers has led to investments in the above sectors.
Attractive valuations, above‐average growth rates, and strong demand tailwinds have
supported these sectors in their historical growth trajectory.
There are currently 23 small cap funds in India with a total AUM of Rs 1.33 lakh crore (as of March 2023), out of which more than 95% of the funds had their allocations in the chemical, consumer, and construction sectors.
Over the last year, more than 50% of the small‐cap fund managers have reduced weights and partially booked profits for their investments in these sectors. The Consumer Durable industry has witnessed substantial growth and investment interest with the rising disposable income and increasing spending power of the expanding middle class in the country. Lifestyle changes and urbanization have jointly supported the demand
for consumer appliances.
Smallcap fund managers recognized this trend earlier and allocated investments in companies that would leap benefits from this increasing demand.
Fund managers have preferred companies that can evolve with technological advancements to meet customer expectations since it is essential for long-term sustenance in a competitive market of consumer durable products.
Favourable government incentives have also recently added additional support to companies for better performance.
In recent years, the Specialty Chemical Industry has witnessed phenomenal growth backed by increasing pharmaceutical and agrochemical industry demand. Indian chemical manufacturers have expanded their global footprint by exporting products to international markets.
Speciality chemicals encompass a wide range of products with unique properties and varied applications, attracting fund managers for investments.
Favourable regulatory support with the introduction of the PLI scheme and simplified regulations contributed to the swift growth and capacity expansion of various companies in this sector.
The Building Material sector has been one of the most liked sectors of small‐cap fund managers, with its long‐term growth prospects and direct link to the booming construction and infrastructure industry.
The varied product range and utilities in this sector led to exponential growth; plywood and MDF manufacturing companies had a massive surge in demand due to a sharp fall in imports and an increase in domestic demand, whereas ceramic tile manufacturers had their benefit from increasing exports.
CPVC pipes and adhesive manufacturers have also received outstanding requests in recent years. As economic activities resumed post Covid ‐19 with a rebound in demand for housing,
commercial buildings, and government spending on infrastructure, it’s been the driving force
for building material products and investment interest in the country.
Given the large number of stocks in the small‐cap universe, getting the right sector & proper weightage produces alpha for the fund managers.
Additionally, riding the rising wave in the right industry matters greatly for stock performance.
Although, it is essential to note that all investment decisions taken by fund managers depend on various external and internal factors. External factors which play a crucial role in stock selection are analyzing the economic scenarios, geo‐political situations, and overall market sentiment.
The internal factors influencing decision‐making are the investment philosophy, the objective of the fund, and scrutiny of the company fundamentals. Hence, while these sectors have attracted fund manager interest and generated alpha in the past, new ones might evolve with changing market conditions.
(The author is Fund Manager, Credent AIM Multi Cap Strategy)
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)