We see many attractive investment opportunities in small cap funds at these prices from long term investment horizon

What are your views on inflation, interest rates and global outlook for equities? What are the major headwinds for global equities and emerging market equities in the near term?

Inflation globally as well as in India has cooled off from the highs of 2022 partly due to easing in global commodity prices and partly due to the tightening monetary conditions. It is now not far from central bank targets. But given that favourable base effects will now move out and energy prices remain vulnerable to supply cuts and geopolitics, this last stretch of inflation is expected to be stickier.

With inflation at a comfortable level, Interest rate cycle is close to its peak with some regions like India and the Euro Area done hiking rates and some others like the United States having only 1 or 2 more hikes to go. But to avoid letting inflation expectations from becoming unanchored in case of any flare ups in inflation, most central banks are maintaining a hawkish stance which is keeping upward pressure on bond yields.

Higher interest rates have begun to weigh on economic activity globally and to some extent even in India. As such markets are expecting central banks to loosen up some time in 2024, which will be favourable for equities.

In the near term, higher for longer interest rate environment in the developed world (resulting in lower exports and higher domestic interest rates), uptick in domestic food inflation due to uneven monsoons, higher energy prices, rural slowdown and uncertainty in the run up to the General elections could be headwinds. Globally, overtightening by global central banks remains the biggest risk for financial markets.

What is your medium to long term (3 to 5 years plus) outlook for Indian equities?

Amid positive news from domestic quarters, India is standing out amidst the global uncertainties. Bulk of the high frequency indicators indicate positive momentum be it PMI, GST collections, E-way bills and credit growth. Weak recovery in China is also helping the relative preference for India.

Corporate earnings cycle and macro environment continues to be conducive for a broad-based growth. The economy continues to benefit from fundamentally stronger balance sheet positions of the private sector and the government's supply-side focused policy measures reinvigorating capex.

While relative valuations remain rich, India is in a comfortable spot due to the economic upcycle it finds itself in and strong earnings growth prospects. As such, we are bullish on Indian equities in the medium to long term.

Small caps have seen a great rally this year and there is huge retail investor interest in small cap funds. What are your views on valuations at current price levels?

Small cap indices and some small cap stocks are trading close to long term averages currently. But the opportunity set in the form of the small cap universe of over 1000 stocks is very large. There are pockets of value and several bottom-up stories which are not driven purely by the macroeconomic environment and would still be available at below their fair prices. Through our research, we are confident of building a robust portfolio of 25-60 stocks at reasonable prices to translate into an upside for the portfolio.

Quantum has a track record of judiciously and patiently building portfolios. The Quantum Long Term Value Fund was launched in February 2006 at the then market peak. The fund patiently used corrections to build the portfolio and delivered good performance in the period that followed. Similarly, depending on the prevailing market conditions we will deploy funds judiciously.

Do you see attractive investment opportunities at these prices from a long-term investment horizon perspective? In which sectors you see strong earnings growth potential in the medium to long term?

As Small Cap universe is large and much diversified as compared to large cap universe we see many attractive investment opportunities at these prices from a long-term investment horizon perspective. Themes like Financial inclusion, transition to EVs, Import substitution, China+1, Renewable Energy are themes which we feel have strong earnings potential in the medium to long term.

Financial inclusion includes industries like Small Finance Banks (SFBs), MF Distribution and Broking where with penetration increasing in Tier-II And Tier-III towns the growth potentials are much better. Increasing digital penetration and increasing awareness are drivers for this.

Few Auto Ancillaries are net beneficiaries of increasing Bill of Materials with OEMs (Original Equipment Manufacturers) of the premiumisation trend and transition towards EVs. Also this opens export opportunity for India.

As India is endorsing make in India, companies in the sectors like Electronic Manufacturing Services (EMS) are beneficiaries of this trend. Government incentives like PLI is benefiting them to become competitive in global markets.

Post Covid, globally China+1 theme is gaining importance and India is looked as major manufacturing substitution against China. Sectors like APIs (Active Pharma Ingredients) and Specialty Chemicals are beneficiaries of this trend.

Renewable energy is need of the hour. Countries are focused on going green and India is no exception. So sectors like Green Energy, Water management, waste management are gaining momentum. Regulatory push and incentives are drivers for this sector.

You are launching a small cap fund. What are the salient features of this fund?

The Quantum Small Cap Fund will be backed by Quantum's strong research capabilities to navigate the large (+950 stocks universe), small cap universe. Its vast experience of assessing governance and management quality will add value as smaller companies may not attract the best management talent and may have lower governance standards. Based on financials and CG parameters we will screen ~400-450 names in the universe. The Quantum Small Cap Fund will have a Growth at Reasonable price (GARP) approach and a long-term focus to capitalize on the compounding that small businesses offer. Through extensive research process and efficient research team we will try to meet managements and would initiate extensive research on ~250-300 stocks. Post this we would articulate portfolio of ~25-60 stocks. The fund will be disciplined about fund capacity to avoid large size becoming a hindrance to performance. It will be mindful of liquidity and market cap of underlying stocks which will enable it to hold a high-conviction, liquid portfolio of small cap businesses.

What will be the investment universe of this fund? Will you be looking beyond the Nifty Small cap 250 companies?

Low liquidity and small market capitalization of small cap stocks can lead to risks of exit and sub optimal portfolio. Quantum thus has a well-defined universe to help overcome the traps of Illiquidity and size. The fund's investment universe will consist of stocks with market capitalization between 400 and 21,791 crores and daily trading volumes of minimum 2 crores. There are ~945 stocks meeting the above criteria as of September 30, 2023. Whether a stock is part of small cap indices or not will have no bearing on the investment decision.

Please describe Quantum MF's small cap investment strategy?

First, an investment universe of stocks will be defined based on minimum daily trading volumes and market capitalization

Next, companies will be screened on the below parameters-

• potential for growth
• good capital allocation
• sustainable business model and cash flows
• reasonable valuations that offer potential for capital appreciation
• high standards of corporate governance

Analysts will study stocks in their sector and prepare detailed 5-year projections. Research includes visit notes, financial models, and investment thesis, supplemented with broker research. Regular research meetings will be conducted to review ideas and approve stocks for database. All stocks will be reviewed within 180 days.

The portfolio will reflect 3 broad themes - domestic consumption, exports, and infrastructure development.

The portfolio will have broad exposure to various sectors. Investors get best of bottom-up ideas with a risk control measurement for each sector. Weights assigned to a stock are a function of reliability of management, quality and stability of earnings, upside potential and alternatives/cash available. The fund will have a minimum weight of 2% and maximum weight of 4% at cost to a stock. The benchmark weights of stocks will have no bearing on the portfolio construction.

The Quantum Small Cap Fund will have a Growth at Reasonable Price approach to valuations.

What are the things investors should keep in mind when investing in small cap funds?

The biggest challenge in the small cap mutual fund space today is large Aum size. Funds with large Aum can face liquidity issues if they end up owning a big part of a small cap stock's market capitalization. They may be compelled to have a long tail of stocks with suboptimal weights. They may be forced to either sit on cash or to invest incremental inflows into mid or large cap names, which is not what a small cap fund's objective is.

So, if you're starting to invest in the small cap space, consider a small cap fund which is disciplined about its fund capacity - which can be the differentiator between a well-managed small cap fund and one that isn't. If you're already invested in a small cap fund which has grown too large over the years, consider investing incremental money into a thoughtfully managed small cap fund which prioritizes liquidity over gathering more Aum.

For investors, who are interested in Quantum Small Cap Fund, what should be the recommended minimum investment tenure?

To benefit from the compounding benefits that small cap businesses (businesses and themes which don't have exposure in large caps) can offer as well as to ride out the volatility that comes with investing in this space, investors should have a 5-7 year investment tenure when investing in the Quantum Small Cap Fund.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully