Small-cap Funds: More of The Same
How do mutual funds select small and micro
stocks when most brokers do not track more than 200 stocks and most funds cannot track smaller companies on their own? Well, we looked into the prospectuses closely to see whether they offer any insights into their small-stock selection method or if they have any uniqueness. Unfortunately, all prospectuses speak in generalities. Here is a summarised version of the stock-selection processes of various fund houses:
DBS Chola: Fundamentally sound companies which can deliver superior earnings growth in the long run, based on top-down (sectors that can offer long-term growth) and bottom-up (companies with high profitability and scalability supported by competitive advantages) approach. Would aim at controlling risk through research and diversification, based on enduring business model, management quality, change in business fundamentals and valuation.

HSBC: Companies that have strong fundamentals, high growth potential and are under-priced, based on a top-down and bottom-up approach. Selection will be based on business fundamentals, industry structure, management quality, sensitivity to economic factors, financial strength, etc.

ICICI Pru: Companies whose market capitalisation is very small but have the potential to become large because of strong/upcoming business line, quality management, improving margins, etc., and are currently trading at modest valuations. Will take a long-term call, based on business and economic fundamentals founded on in-depth research, using both bottom-up and top-down approach.

DSP Merrill: Will focus on companies which seek to improve every year by capitalising on various strengths and those that are currently in the growth phase. Company-wise research will focus on its historical and current financial condition, potential value creation/unlocking and its impact on earnings growth, capital structure, business prospects, strength of management, product, brand equity, market share, competitive edge and transparency in corporate governance, etc.

Franklin: The only fund that did not discuss its stock-selection process in the prospectus. Sundaram: Emphasis on the growth potential of the company as well as the sector to which the company belongs. The fund manager will pick stocks that have better growth opportunities. However, value investing will also be done, if the equity markets and industrial activity necessitate such a decision.

JP Morgan: Companies that have a strong growth potential, with a special product, and companies undertaking corporate restructuring. Approach will be bottom-up stock picking without any sector-bias. Identify companies which have the potential to scale up significantly to become much larger in the medium to long term.
Can you detect any major differences between the funds?

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