Dhiraj Sachdev makes a compelling case for investing in the HSBC Small Cap Equity Fund:

• Portfolio P/E of about 14-15x one year forward earnings with EPS growth at 20% allays concerns around “overvaluations” in small caps
• 5 year CAGR of 27.76%^^ with healthy alpha of 7.49%^^ over its benchmark demonstrates wealth creation and alpha generation capabilities.
• Businesses that Dhiraj tracks are reporting robust growth in order books giving strong visibility on earnings growth. Besides choice is to be in businesses that are scalable and capital efficient.
• Spending ahead of general elections should give a fillip to economic activity, reinforcing the fund manager’s decision to remain overweight cyclicals, rural and infra themes.

WF: Your Mid Cap Equity Fund has now become the HSBC Small Cap Equity Fund. What implications on portfolio strategy and composition arise out of this change?

Dhiraj: The fund is already complying with the small cap definition as per the categorization laid down by SEBI. From our perspective, there is no change in terms of reallocation from mid cap to small cap. The mandate requires a minimum of 65% in small cap and we are already around 66.63% in small caps as at March 2018.

WF: One of the big challenges arising from scheme rationalization is the challenge of comparing past performance within a peer set. How will the small caps peer group composition change consequent to implementation of the scheme rationalization move?

Dhiraj: Now, there will be further refinement of the peer set and it is good for the industry because the comparison will be like to like. We welcome that change of peer comparison which is more refined now and in the industry, part of the mid cap funds which are not as large are getting shifted to small cap. So we will have more number of peers in the small cap base. As a result, there will be lot more relevant competition. Competition was always there. It is not increasing the competition intensity but making it more relevant.

“It is a myth that mid and small caps are expensive compared to large caps and therefore cannot give you healthy returns whereas large caps can.”

WF: Mid and small caps have been at the center of the overvaluation worries that markets have been talking about since last year. What is your sense on valuations in the small caps space now?

Dhiraj: It is a myth that mid and small caps are expensive while large caps are cheaper and that mid and small caps will not therefore give you healthy returns while large caps can. The small and mid-cap space is a large universe of stocks. There are not a few hundred but few thousand companies listed on the exchange. There are a large number of SME companies getting listed each month.

There will be pockets of overvaluation but there will also be several companies within the couple of thousand companies where you will find that valuations are attractive, the earnings growth is estimated to be secular, there is a scalable business model and where balance sheet is improving or healthy enough

Fund Managers aims to identify the right stocks, select those companies that create alpha over a period of time. We don't go by the argument that small caps and mid caps are expensive and large caps are preferred because even if you see the large caps, some of the technology or pharma companies for example have given mediocre or no returns over the last 2 to 3 years. So it is not about the size of the company, as much as what kind of company you own, what business that company is in -- that matters more than the size of the company.

WF: Some prominent small cap funds are currently closed for fresh subscriptions, as fund managers express difficulties in allocating fresh money optimally in the current market. Are you finding attractive opportunities at reasonable prices now?

Dhiraj: In the few thousand companies, there has always been mispricing and misappraisal of some companies, That is what we try to identify. Our investment process also aims to find possible mispriced opportunities. We endeavor to get into the companies at an early stage of investing before the market identifies them fairly or rerates them completely.

We still find lots of opportunities across many businesses like agro chemicals, some auto ancillary companies, industrials and capitals goods, specialty chemicals and emerging business like aquaculture. So across different businesses, we find valuation reasonable for long term compounding and that is the key for any retail investor - that is how the wealth creation happens.

If you are not finding value to deploy new money, does that mean you don't find value in the existing portfolio of companies? If you are not unwinding the entire portfolio that means there is still value in the existing holdings itself.

The issue is that when small cap funds grow too large, there is an impact cost of entering and exiting stocks to either create meaningful positions or exit positions that you already own – which is anyway a challenge for existing investors of such “large sized” small cap funds.

WF: What is the earnings growth momentum in your portfolio and what is its current P/E?

Dhiraj: Our portfolio P/E on a 1 year forward basis is in the 14-15x range and earnings growth of our portfolio stocks is in the region of close to 20%. So, on a PEG basis, our portfolio is well placed. We are fairly conscious about valuations and we don't buy companies which are expensive and popular, because typically popular companies are already well discounted in the market.

History indicates that in the quarters before an impending election, the economic cycle tends to accelerate as the government showcases and spends more on areas like infrastructure (or even affordable housing this year).

WF: Some fund managers are preferring to go a little defensive in the current market, while your portfolio suggests continued bullishness on cyclicals. What is your take on the economic recovery cycle?

Dhiraj: We believe that economic recovery is on the way. When we talk to industrials and infrastructure companies, they are sitting on order books that are upto 3 years of their revenue cycle. The book buildup is pretty favourable and shows recovery is on its way. If you see the government's spending on roads, railways, defense, power transmission & distribution etc., the spending has actually accelerated, especially on the road sector. From about 26 kms per day, the ambition is to make it to over 40 kms a day. Compare this to what we were few years back, we were hardly at 10 kms per day – so the acceleration is happening.

We have learned from history that whenever we have an impending election in the subsequent year, the previous few quarters before the election, the economic cycle tends to accelerate because the government showcases and spends more on areas like infrastructure. Given the government focus, affordable housing is also getting created that may have multiplier effect on many other sectors as well like steel, cement, etc.

So that is why our preference is for the cyclical side of the business apart from businesses that may benefit from rise in rural income like seeds, Farm Mechanisation equipments, Crop protection products, etc.

The global metal market has recovered and so metal companies have started their capacity expansion plans-- that shows capex cycle is gathering momentum. These are all added points that indicate that industrial recovery is on the way.

WF: What in your view is the investment argument for this fund now?

Dhiraj: Our whole investment argument for this fund is based on 3 ingredients: We buy companies #1 which will have scalability of business, #2 – where the earnings growth is expected to be more secular, # 3 – are available at a reasonable valuations.

With these 3 ingredients and stock selection, we believe alpha creation opportunity exists.

This fund has delivered a CAGR of 27.76%^^ over the last 5 years, during which time, its alpha has been at 7.49%^^ over its benchmark. During 3 years period the fund has delivered 16.67% return, while its benchmark has delivered 15.31% returns. We endeavor to generate superior alpha over average market returns through our stock selection and investment process.

^^ Please refer below the detailed performance of HSBC Small Cap Equity Fund and of the other funds managed by the Fund Manager.

NA means not available.
*Pursuant to the circular issued by SEBI on ‘Categorization and Rationalization of the Schemes, there has been change in the fundamental attribute(s) of the aforesaid scheme including change in the benchmark to S&P BSE 250 Small Cap Index effective from Mar 14, 2018. The launch date of the S&P BSE 250 Small Cap Index (INR) is November 30, 2017 whereas the inception date of the scheme is May 19, 2005. All information presented prior to the index launch date is back-tested which is available from Mar 31, 2008. The corresponding benchmark returns since inception of the scheme is not available. All index data is available on the website of Asia Index Pvt. Ltd. a joint venture between BSE Ltd. and S&P Dow Jones Indices LLC. (source: source: http://www.asiaindex.co.in/indices/equity/sp-bse- 250-smallcap-index). Performance of the respective benchmark is calculated as per the Total Return Index (TRI) Index returns.

Returns are of growth option. The returns for the respective periods are provided as on 31 March 2018. Returns above 1 year are Compounded Annualized. Standard benchmark is prescribed by SEBI and is used for comparison purposes. Returns on 10,000 are point-to-point returns for the specific time period, invested at the start of the period. The returns provided above have been rounded off and hence there may be minor differences between point-to-point returns vis-a-vis returns indicated above. Different plans shall have a different expense structure. The performance details provided herein are of other than Direct plan. Scheme count for the total schemes managed by the Fund Managers does not include closed ended scheme.

Performance of other funds managed by the Fund Manager

NA – Not applicable
Performance of the respective benchmark is calculated as per the Total Return Index (TRI) Index returns reported as on 31 December 2017 were in USD, however the returns are now converted to INR and these values have been sourced directly from Bloomberg.
#Pursuant to the circular issued by SEBI on ‘Categorization and Rationalization of the Schemes, there has been change in the fundamental attribute(s) of the aforesaid effective from Mar 14, 2018.
$The launch date of the S&PBSE India Infrastructure Index (INR) is May 19, 2014 whereas the inception date of the scheme is Feb 23, 2006. Information presented for 5 year return is back-tested which is available from Mar 31, 2008. The corresponding benchmark returns since inception of the scheme is not available. All index data is available on the website of Asia Index Pvt. Ltd. a joint venture between BSE Ltd. and S&P Dow Jones Indices LLC. (source: http://www.asiaindex.co.in).#Pursuant to the circular issued by SEBI on ‘Categorization and Rationalization of the Schemes, there has been change in the fundamental attribute(s) of the aforesaid effective from Mar 14, 2018.
Returns are of growth option. The returns for the respective periods are provided as on 31 March 2018. Returns above 1 year are Compounded Annualized. Standard benchmark is prescribed by SEBI and is used for comparison purposes. Returns on 10,000 are point-to-point returns for the specific time period, invested at the start of the period. The returns provided above have been rounded off and hence there may be minor differences between point-to-point returns vis-a-vis returns indicated above. Different plans shall have a different expense structure. The performance details provided herein are of other than Direct plan. Scheme count for the total schemes managed by the Fund Managers does not include closed ended scheme.

Disclaimer

Expressions of opinion are those of HSBC only and are subject to change without any prior intimation or notice. It does not have regard to specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies that may have been discussed or recommended in this report and should understand that the views regarding future prospects may or may not be realised. Neither this document nor the units of HSBC Mutual Fund have been registered in any jurisdiction. The distribution of this document in certain jurisdictions may be restricted or totally prohibited and accordingly, persons who come into possession of this document are required to inform themselves about, and to observe, any such restrictions.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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Email: hsbcmf@camsonline.com | Website: www.assetmanagement.hsbc.com/in

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