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5 reasons why small caps still look attractiveDhruv Bhatia, Bank of India MF, Mumbai

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Dhruv lists 5 key reasons why small caps still look attractive despite the recent run up:

-         Small caps’ rolling returns over last 3, 5, 7 and10 yrs have been around 15% CAGR and these are almost entirely backed by earnings growth – valuation expansion has been minimal.

-         Despite a sharp rally in recent months, small caps are trading around 15x 1 yr fwd earnings – around their historical average.

-         They haven’t also significantly outperformed large caps yet to warrant caution – like the signals we saw in 2008 and 2018,when they ran far ahead of large caps on a relative basis.

-         Small caps capture the manufacturing/capex revival best, with 40% of the index being represented by this space. On ground activity is high, earnings visibility is strong, valuations are yet reasonable compared to growth prospects.

-         The holy grail for business health is RoE – and small cap stocks are seeing significant RoE expansion on the back of cleaned up balance sheets and robust earnings growth, which sets them up well to capitalize on the economy’s growth momentum.

Within the small caps space, Dhruv is bullish on auto ancillaries, manufacturing/capital goods and pharma. He is cautious on some pockets of the chemicals space and the consumer space. IT is a sector he is now gradually moving from sceptical to constructive.

BoI Small Cap Fund has slipped a bit in its 1 yr performance ranking. Attribution analysis suggests it was more of stock selection rather than sector calls that detracted from performance in recent months – in an environment where poorer quality names started outperforming quality businesses as the rally broadened. Dhruv has taken proactive action on the portfolio and is confident about his portfolio delivering to investor expectations going forward.

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