Prime Recommendation: Union Small Cap – A small-cap fund without size constraint

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Small caps are not particularly attractive post the March lows. And yet, after almost 2 years of underperformance, this segment is seeing a new set of companies rallying swiftly, to make up for the years of suppressed performance. And several of them are backed by fundamentals.

 If you therefore decide to ride this new wave with a small-cap fund, it is not that easy. You may have to wonder whether the fund you pick will restrict inflows in a while or suffer in performance if its AUM grows rapidly.

So, this time around, in our quarterly review, we dug deeper into the small-cap space to see if we can overcome this constraint without compromising on the quality of the portfolio. And we think we have the one.

Why this is a risky bet and why we chose it

Union Small Cap is the new addition to our Prime Funds’ list. It is a high-risk bet, even in the small-cap space, for the following reasons:

  • it is an emerging performer and not time-tested.
  • It has seen a marked improvement since the addition of seasoned fund manager Vinay Paharia in April 2018. Its performance may therefore hinge on fund management stability.
  • It is from a fund house that, not so long ago, has been at the bottom of performance chart across equity products but seeing an uptick now. The longer-term rolling returns chart below will tell you the fund’s noticeable underperformance over the category average and how this has steadily narrowed and then moved to a zone of outperformance now.

These risks notwithstanding, we added Union Small Cap for the following reasons:

  • Steady improvement in our ratings chart, buttressed by a mix of high quality and high growth companies in its portfolio.
  • Addition of seasoned fund manager Vinay Paharia in April 2018 and a visible difference in portfolio make up and performance a year after his entry.
  • A nimble AUM size that allows navigation of the small-cap space, without fear of impact cost or liquidity.

These points are detailed below.

Turnaround in performance

Union Small Cap beat the small-cap category average 87% of the times when 1-year returns were rolled daily between 2016-20. As the chart below will show you, the fund was marginally underperforming SBI Small Cap and significantly trailing Axis Small Cap. This gap started narrowing in 2020. The fund raced ahead post the correction.

But the chart will also tell you that there is little comfort to take from its past performance. What lends comfort is the changes it made to its portfolio, especially from mid-2018, after Vinay Paharia joined the team. Portfolio turnover can give a good insight into changes that a new fund manager may bring about. Between July 2018 and June 2019, the portfolio turnover stood at 92%, far higher than the average 48% for the six months ending March 2018 (before the entry of the new fund manager cum CIO).  

In the revamped portfolio, quality and growth took precedence over valuation. And we think this laid the foundation for the fund’s recent outperformance. While many stocks were added, stocks with ripe valuations or underperformers also exited the portfolio over the above-mentioned period. As a result, while the fund did fall more than top peers in the March 2020 correction, it rose quickly in the ensuing rally, thanks to the quality portfolio that we discuss in the next section.

Resilient portfolio

If you scan the portfolio of Union Small Cap, you will see quite a few stocks that doubled in the last 6 months. You will find strong resilience in the earnings of these stocks even in the Covid-19 hit June quarter.

About 30% of the stocks saw a growth in earnings in the June quarter over a year ago, suggesting that the stocks’ rally was backed by sound growth stories. Pharma and healthcare stocks such as Alembic Pharmaceuticals, IPCA Laboratories and Laurus Labs, JB Chemicals & Pharmaceuticals, chemical plays such as PI Industries, tech plays such as Indiamart Intermesh, Birlasoft or Tata Elxsi are few examples of an earnings resilient story that the fund has drawn for itself over the past year and a half.

The current macro environment offers a good opportunity to test a company’s resilience in a slowdown phase and on this metric, the fund’s portfolio offers comfort that it has been filtered with sound metrics. While earnings for the fund’s portfolio fell by 23% over a year ago in the June quarter, it was a far better show than the 50% earnings fall of bellwether companies in Nifty 50.

Overall, this portfolio rehash along with tactical opportunities in the form of IPOs helped the fund shore up performance.

No size constraint

You may be aware that many of the top performing small-cap funds have restrictions on inflows. Higher inflows in small-cap funds cause 2 kinds of challenges to fund houses: one, finding quality opportunities in the small-cap space; two, deploying money or exiting stocks without incurring heavy impact cost. Union Small Cap scores on this front. Sample the data below of AUM size of some of the popular funds.

You will see that Union Small Cap has significant leeway to navigate this space without fear of stock liquidity. To put this in perspective, the fund can technically liquidate its entire portfolio (based on individual stock volumes and its own size) in 3.2 days, as opposed to 13 days for Nippon Small Cap, 24 days for Axis Small Cap or 39 days for HDFC Small Cap.

Suitability

We have highlighted the risks in this fund upfront. The reason for the same is that you should best view this as a dark horse bet. Take not more than 5-8% exposure and that too through SIPs and see how it performs. We will not hesitate to call out on any management change or changes in the AMC itself. Hence do not view this as a ‘buy & hold’ long-term candidate. Check for our review quarterly or half yearly on our MF Review Tool.

As a fund with small AUM size, expense ratio is not low. Go for the direct route where possible.

With inputs from Anush Raj P

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Please note that any specific queries on any of our recommendations will be answered ONLY through email. If you are a subscriber, please mail contact@primeinvestor.in.  Only general queries or discussions will be answered through the comment section of the blog. For full details, please refer to this post – How to communicate with PrimeInvestor.

20 thoughts on “Prime Recommendation: Union Small Cap – A small-cap fund without size constraint”

  1. Can you please include Principal Small Cap when comparing small cap funds ? Similar to Union Small Cap the AUM is less and the fund manager has a good track record in previous AMCs

    1. It does not have sufficient track record. Besides with the takeover by Sundaram MF, best to watch as they too have a smallcap fund and it might mean a merger. thanks, Vidya

  2. Hi Vidya,

    Great Insights! Just one thought on this, maybe you can correct me here. With such low AUM, if any big redemption happens and market conditions are not favorable, don’t you think it will impact the existing investors’ returns? You did mention the risk and potential exposure one can take in this fund. However, wanted to get your views on the low AUM part specifically.

    Thanks.

    1. No it won’t. Since the fund has very small holdings in each stock (which is why its portfolio is highly liquid), it will not have a problem selling. The losses of course will be there if the market is falling. That will be true of any fund facing redemption pressure. thanks, Vidya

  3. Hi Vidya, It’s good that we capture small cap . And when they are at a nacent stage. I had been reading your post from several years prior to primeinvestor days.
    Coming to Union small cap considering there is a risk, at what stage should I exit at the lower side, if say the analysis or any other factors goes against investment strategy.

    1. Thanks. We will let you know if there is an issue with the fund. So just check the review tool once a quarter or half year. otherwise, please rebalance your porfolio periodically based on the rebalancing article we mentioned (nothing specific for smallcaps..general rebalancing) to ensure profits are booked periodically. thanks,Vidya

  4. Madam, what is your opinion on infrastructure funds , and please suggest one or two good funds. i can hold another 5years plus. already i am holding last two years itself.

  5. Hi Vidya,
    Your comment “the fund can technically liquidate its entire portfolio (based on individual stock volumes and its own size) in 3.2 days, as opposed to 13 days for Nippon Small Cap, 24 days for Axis Small Cap or 39 days for HDFC Small Cap.”
    While this is an interesting perspective (thank you!), I find it surprising that Nippon needs 13 days while Axis needs 24 days. Can you please re-confirm? While I expect that this depends on the particular holdings, given the dramatic difference in AUM, this magnitude of difference (and that too Nippon being lower than Axis) is surprising.
    Thanks.

    1. Sir – this is what data from our database says, based on individual stock volume and the weights in the portfolio. It is not just about AUM – it is about the individual stock’s liquidity and how much the fund holds in it. thanks, Vidya

  6. What I understood from the article is Union Small Cap has become Prime Fund because of Mr. Vinay as FM.

    “When you do it once people claim it as luck, when you repeatedly do it, people see it as talent. ”

    The very question boils down to what are his past success stories on which we are so confident to include this fund as a Prime Fund with just recent past outperformance history?

    1. FM is one of the reasons – not the only reason. If we are confident about FMs alone, you will find Prashant Jain and Naren funds in our list. But there aren’t 🙂 if we have to write about the FM’s past record in Invesco, we need a separate article 🙂 You may have to trust us on this given our 2 decade experience in tracking the industry! We have clearly stated that the new FM has changed the portfolio and we think the portfolio holds promise and have gone so far as to saying the portfolio’s returns and earnings and pontential! If you are uncomfotable with a small fund, why not look at larger funds? This is not the only one we have given and we are not distributors to be markting specific funds 🙂 thanks, Vidya

  7. As I see the graph, fund underperformed for almost Jul’17 till Q4 2019 …and it started matching or beating from Q4’19 ….and you’re recommending with such a small period of track record? Isn’t it a bit hurried in recommendation? Also, Union AMC as a fund house doesn’t have much credibility. Thoughts/ Comments?

    1. Sir, I think we have stated upfront that the turnaround is short and also why we are still giving. If we don’t catch something timely you ask us why we missed the bus. When we do, you ask us why we give an early call 😀 That was on a lighter note!
      Union did not have creditbility issues Their performance was downright bad. We have followed inay Paharia for very long now and we do see that the fund house is seeing changes since his entry.
      Vidya

      1. Thanks Vidya …for a clarification. On a serious note, my question is NOT challenging your recommendations but more of clarifying to get myself financially educated and responsible.

        Thanks for an amazing work your team has been doing so far …looking fwd to a continued mutually benefitting relationship.

        1. Hello Sir, I did not feel challenged at all 🙂 It’s perfectly fine! I was, if I may say, a bit amused by some of you asking us to spot early calls and some asking why it is early. Multi-dimensional investor thoughts 🙂 And end of day, sir, the call works or it doesn’t. We take onus for that and course correct when we are wrong, before it is too late. That is the best one can do! Since we are not tied to any AMC as agents you will at least know our motive was clear. We always look forward to your questions and helping investors empower themselves. thanks, Vidya

  8. This is the third time I am reading about Union small cap in the last 10 days

    Any reasons to write on this small, new fund so regularly.

  9. Vidya, Very nice article with lot of good data points. How does this fund compare to the passive fund of Motilal Oswal small cap 250? It would have been good to have a comparison with a passive small cap fund. Is it a good idea to switch from HDFC small cap to Union small cap fund?

    1. Motilal oswal index fund ahs a 1 yr track record. Can’t be compared. But to comapre the inde, yes the fund ahs been beating the Nifty 250 over 1-year rolling periods..but in recent months with all sorts of smallcaps running up all indices have beat funds oevr 3-6m period. We see that as temporary. In small-caps funds far outperformed indices thus far. thanks, Vidya

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