As investors, most of us spend a considerable amount of time window-shopping for the right investment avenues. “Should I invest in the safety of debt instruments or should I stay equity-focused? Should I pick evergreen stocks or can I benefit more from trading the seasonal ones? What about adding some cryptocurrencies to my portfolio? How long should I stay invested?” Questions, so many questions.

The truth is that unless you’re an exceptionally nuanced investor with well-rounded insights about multiple sectors, a diversified portfolio can hold the answer to most ‘what and why questions as far as investments are concerned. Two financial avenues facilitate this diversification optimally; the first is a household name and the second has emerged as a buzzword in the last year or two. Mutual funds and Smallcases are the two asset structures in contention, and we’ll compare them over the course of this article to understand the fundamental difference between Smallcase and mutual funds.

What are mutual funds?

A mutual fund is a pool of money collected from many investors to invest in securities like stocks, bonds and other assets. Professional fund managers, vetted and hired by mutual fund houses or Asset Management Companies (AMCs) are responsible for picking the constituents of the fund and allocating capital; they can attempt capital gains or income production based on the investment objectives of the fund as per the prospectus set out at the time of the fund launch (called NFO).

What is a Smallcase?

A Smallcase, on the other hand, represents a capital allocation structure similar to portfolio management services (PMS) that were previously reserved for wealthy individuals (Read: HNIs and UHNIs). As a product, this is an idea that has caught the fancy of many well-heeled millennials as well as on-the-brink wealthy, ever since SEBI hiked the minimum investment amount for portfolio management services (PMS) from ₹25 lakh to ₹50 lakh in November 2019. In some sense, Smallcase may be called affordable PMS – with a starting price as low as Rs199/month. Basically, a Smallcase is a basket of stocks or ETFs, decisively created by the top qualified and registered investment advisors (RIAs) in India, based upon a theme, strategy, or objective.

David vs Goliath: A legacy product vs a promising challenger

If we have to compare the sheer size of the market with respect to Assets Under Management (AUM), mutual funds represent ₹36.74 trillion as of September 30, 2021. In comparison, Smallcases are a disruptive product that has been around for approximately 6 years now. Quoting the founder and CEO Vasanth Kamath “Our users multiplied three times from 9 lakh in March 2020 to 28 lakh in March 2021.” In FY21, the firm saw Rs 8,000 crore invested through its platform. A drop in the ocean, as far as the larger financial products industry is concerned.

Smallcase vs Mutual Funds: Points of Comparison

 

1. Exercise Control

Investing in Smallcases potentially offers investors better control over securities as the shares are credited directly in the Demat account. Having the portfolio right at your fingertips allows you to time your exit and know where each investment goes, which isn’t possible with mutual funds; you can cherry-pick which mutual fund you want to invest in, but the customization ends there.

2. Risk Mitigation Mechanisms

Smallcases are thematic investments; they invest in companies and securities that follow an underlying strategy or idea. For example, there can be a Smallcase that focuses on Clean Energy companies or fast-growing tech companies that focus on enterprise software integrations. Since these ideas are highly specific, diversification is restricted. For those intent on diversification, mutual funds offer a basket of good companies that are related by larger themes such as industry type and revenue benchmarks that may be a better hedge against volatility over several business cycles.

3. Cost of Leaving

In many mutual funds, there is an in-built penalty for liquidating your assets before the minimum stipulated time (generally just about a year)- this expense is called the exit load which ranges from 1-2% of the total investment. Typically, all mutual fund houses adjust this amount against the net asset value (NAV) of the fund. Smallcases, by design, allow investors to buy individual units of securities that are directly credited in the demat account like common shares. Since there is no exit load on selling shares, there is no exit load on selling smallcases.

4. Management Fee

Any asset allocation structure is only as good as the people managing it, i.e., the fund manager- who in these cases is typically someone who holds high repute in the financial markets. Understandably, this expertise attracts a certain cost, apart from the cost of monitoring and managing the fund. In the case of mutual funds, this cost, called the expense ratio, is a percentage of the total fund value, capped at 2.5% by SEBI. Smallcases have no fixed range – the cost differs from case to case and RIA to RIA, depending on the nature and theme of the basket of investments. For example, TejiMandi charges just Rs 199/month for its smallcases!

5. Access to Returns

Smallcases give investors direct access to their holdings since the shares are directly credited to their demat account. Hence, all corporate actions such as dividend distribution as well as the issue of bonus shares take place directly with the investors. In the case of mutual funds, the returns are collected in real-time but distributed quarterly.

6. Volatility

Due to the nature of the theme-wide concentration of Smallcases, they are typically more volatile than the stock market in general since the risk is concentrated in a specific strategy or idea. However, as one of the fundamental principles of finance states – the higher the risk, the higher is your potential for gains. Mutual funds, on the other hand, spread the risk across companies working in different areas even if the fund is concentrated in a specific industry. Hence, the latter is more resilient during market ups and downs.

Here is a quick summary of the points of comparison:

BasisSmallcaseMutual Funds
ControlAllows greater control over securities.Comparatively less control and less scope for customisation.
Risk mitigation mechanismsLess diversification with a focus on specific themes. This restricts the scope of risk mitigation. Diversified across various sectors, allowing greater risk management. 
Cost of LeavingNo exit load on selling. Exit load is adjusted with the NAV of the fund. 
Management feeNo fixed range. Differs from case to case.Capped at 2.5% by SEBI.
Access to returnsDirect and immediate access to returns, dividends, bonus shares, and more.Returns are collected in real time but are distributed quarterly.
VolatilityMore volatile because investment is in one area, concentrating the risk.Less volatility as investment is spread across various sectors.

Where should you invest?

While choosing between mutual funds and Smallcases, you must consider the following questions:

  • Do you have adequate knowledge of the market?

Investing in a Smallcase requires some degree of market research and ample time to sort through to find the best Smallcase to invest in. It is an excellent investment for those who have a good idea of how markets operate. However, you can invest in a mutual fund without any market knowledge.

  • How much control do you want over your investment?

Smallcases allow you greater flexibility, transparency, and control over your portfolio. You can choose a Smallcase that aligns closely to your financial goals and ideas, giving you greater discretion. On the other hand, investing in mutual funds comes with comparatively low transparency, and you have minimal influence over your portfolio.

  • For how long do you want to park your funds?

Smallcases come with no lock-in periods, while mutual funds require you to lock-in your money for a considerable amount of time. Moreover, the charges associated with mutual funds are higher.

  • How much time are you willing to spend on tracking your investment?

Investing in Smallcases requires you to keep a tab on your investment. You will have to decide when to enter the market and when to exit it to get the most returns. You may also have to keep a check on the returns to make sure they are on track. As for mutual funds, you can simply invest and let the experts take care of your investment. You may review it once a year.

Based on how you answer these questions, you may choose between these two investment avenues.

Closing Thoughts

As far as investments as concerned, asset allocation structures are as effective as the investor’s understanding of their goals. Both Smallcase and mutual funds are excellent avenues for growing wealth and intelligent investors should use these tools judiciously to their benefit. Where mutual funds provide the diversification a portfolio might need, Smallcases are conveniently packaged customizable investments in simple ideas that could return well over time.