Mutual Fund Review: DSP BlackRock Micro Cap fund

DSP BlackRock Micro Cap Fund aims to generate superior returns by investing in a diversified portfolio of small and mid-cap companies with high growth potential. In this fund a majority of the portfolio is allocated to small cap companies. While inherently, small and mid-cap funds are riskier than large cap funds, they have the potential to generate superior returns, since midcap companies generally have higher growth potential compared to large cap companies, both in terms of earnings and valuations. See the chart below, for the comparison of annualized returns over one, three, five and ten year periods, between small and mid-cap Funds and the large cap funds categories (NAVs as on Apr 8)

The outperformance of the small & mid-cap fund versus large cap category is despite the fact, that the mid cap stocks have lagged behind the market. While the Nifty has gained almost 21% in the last one year, the mid-cap index (CNX Midcap) gained about 16%. The recent rally in the markets has seen renewed interest in mid and small cap stocks. However, many mid-cap and small cap stocks are still trading at very attractive valuations and their future outlook, as the market recovers, is very positive.

Among the small & midcap funds, DSP BlackRock Microcap fund has given a very strong performance over the last 5 years. It has done very well in capturing the upside in bull markets, but has been volatile in the bear markets. See the chart below for annual returns of the fund for every year since inception, compared with benchmark (CNX Midcap returns)

In terms of 5 year trailing annualized returns, this fund has given the highest returns in the small and midcap funds category. Please see the chart below for the trailing annualized returns of DSP Blackrock Microcap for 1, 2, 3, 4 and 5 years, in comparison with Midcap funds, Large Cap funds and the benchmark CNX Midcap index.

DSP BlackRock Micro Cap – Fund Overview

This fund is suitable for investors with high risk tolerance, looking for high capital appreciation over the long term. However, investors in this fund should be comfortable with high volatilities of NAVs and returns. As such the fund is suitable for investors who have a sufficiently long time horizon. The fund was launched in March 2007. It has an AUM base of about Rs 350 crores. The expense ratio of this fund is 2.54%. The fund managers of this scheme are Vinit Sambre, Apoorva Shah and Mehul Jani. The scheme is open both for growth and dividend plans. The current NAV (as on Apr 8 2014) is 20.1 for the growth plan and 12.2 for the dividend plan.

Portfolio Construction

The portfolio has a bias for small and micro cap stocks with high growth potential. The fund managers have long term buy and hold approach, backed by strong research. In terms of sector allocations, the portfolio is weighted towards Healthcare and BFSI, with substantial allocations to Engineering, Chemicals and Textiles. In terms of company concentration, the portfolio is well diversified with its top 5 holdings, accounting for only 29% of the total portfolio value.

Risk & Return

From a risk perspective, the volatility of the fund is on the higher side. The annualized standard deviations of monthly returns of DSP BlackRock Micro Cap Fund for three and five year periods are 19.5% and 28.7% respectively, which is on the higher side even relative to the riskier small and mid cap category. While the high volatility is definitely a watch out for the fund from a risk perspective, the risk adjusted return is very attractive. On a risk adjusted basis, as measured by Sharpe Ratio, the fund has outperformed the diversified category . Sharpe ratio is defined as the ratio of excess return (i.e. difference of return of the fund and risk free return from Government securities) and annualized standard deviation of returns. Higher the Sharpe ratio better is the risk adjusted performance of the fund. See charts below for comparison of volatilities and Sharpe ratios between DSP BlackRock Micro Cap fund and small and midcap funds category

Comparison with Peer Set

A comparison of annualized returns of DSP BlackRock Micro Cap fund versus its peer set over various time periods shows why this fund is considered a top pick in its category. See chart below for comparison of annualized returns over one, three and five year periods. NAVs as on Apr 8 2014.

SIP and Lump Sum Returns

The chart below shows returns as on Apr 8 2014 (NAV of 20.1) of Rs 5000 monthly SIP in the DSP BlackRock Micro Cap fund Growth Plan, for respective years since inception (in Mar 2007). The SIP date has been assumed to first working day of the month. The amounts are shown in Rs lakhs.

The chart above shows that a monthly SIP of Rs 5000 started on July 2007 in the fund would have grown to over Rs 7 lakhs, while the investor would have invested in total only Rs 3.9 lakhs. If the investor had invested a lump sum amount of Rs 1 lakh in the NFO in June 2007, his or her investment would have more than doubled during this period.

Conclusion

The DSP BlackRock Micro Cap has delivered strong performance over the past 5 years, in what can be described as difficult market conditions for this sector. With the improving sentiments in the Indian equity markets and the value based investing approach of the fund managers the fund seems poised to deliver even stronger performance in the future. Investors with high risk tolerance can consider investing in the fund through the systematic investment plan (SIP) route for their long term financial planning objectives. Even though small and midcap funds like DSP BlackRock Micro Cap fund can give higher returns than large cap or diversified equity funds, investors should also remember that the risk associated with small and midcap funds are higher. Investors should consult with their financial advisors if this fund is suitable for their investment portfolio, in line with their risk profiles.