Strongest earnings growth now concentrated outside Top 100 stocks, mid- and small-caps lead

The fund will invest mainly in companies ranked between 101 and 750 by market capitalisation, with a concentrated portfolio of 25 to 40 stocks. It can also take unhedged short positions through equity derivatives, capped at 25% of the portfolio. Madanagopal Ramu, fund manager – equity at Sundaram Asset Management, said the strategy was based on an observation that earnings momentum was currently stronger outside the large-cap universe.

“Mid- and small-cap companies are producing a far higher share of businesses growing sales, EBITDA and profit by more than 25% year-on-year compared with large-caps,” Ramu said. “Large-caps offer better valuation comfort, but the growth is more visible in the ex-Top 100 segment.” Why mid- and small-caps Ramu linked the earnings divergence to a broadening capital expenditure cycle. Globally, he said, spending related to artificial intelligence was extending beyond software into hardware and power infrastructure.

In India, capital goods output has grown in the high teens for nearly 10 consecutive months — a run he described as unusual in his 15 years of tracking the sector. Capital expenditure, which had fallen below GDP growth during the pandemic, is now growing at roughly 2.5 times the pace of GDP expansion, Ramu said. Private-sector capex is also beginning to recover, supported by improving credit conditions.

Credit data adds to that case. India is one of only three countries, alongside Indonesia and Vietnam, currently recording double-digit credit growth, according to Ramu. Systemic credit growth is running at 15-18%, while corporate credit, subdued in recent years, is beginning to pick up. Job creation remains in the 5-10% monthly range across most sectors, and gross foreign direct investment remains healthy, he said.

Foreign portfolio investors have been net sellers of Indian equities, but Ramu said their continued investment in Indian startups suggested that global capital remained constructive on the country’s medium-term growth prospects. The valuation problem The fund’s thesis is not simply that mid- and small-caps are cheaper or better. Ramu acknowledged that valuations across parts of the segment remain elevated.

That, he argued, is why the fund will run a concentrated portfolio rather than replicate the broader mid- and small-cap market. A portfolio of 25 to 40 high-conviction stocks selected through bottom-up research is intended to avoid the index-like behaviour of a diversified mid- and small-cap fund. The preferred areas include manufacturing and capital goods, non-banking financial companies participating in the formalisation of credit, and discretionary or premium consumption businesses.

How the long-short strategy works The fund will allocate 65-100% of its portfolio to equity and equity-related securities of companies outside the Top 100, including permitted short exposure. It may invest up to 35% in debt and money-market instruments. Short positions will be taken through derivatives, with unhedged short exposure capped at 25% of the portfolio in line with the Securities and Exchange Board of India’s (SEBI) SIF framework.

Ramu said the strategy was likely to use derivatives for yield enhancement, temporary hedging of long positions and pair trades. Outright naked shorts in individual stocks would be rare, given limited liquidity and the short tenure of single-stock derivative contracts in India. The fund will be benchmarked against the Nifty MidSmall Cap 400 TRI. Sundaram has positioned the product under its Select SIF platform.

The company said it chose a long-short equity strategy rather than a more conservative yield- or arbitrage-oriented offering because it wanted to establish an early presence in the SIF category. “We don’t want to be the 50th fund house to launch a long-short fund. We want to be among the first few,” said Anand Radhakrishnan, managing director and CEO. He added that any long-only fund was essentially an index combined with a long-short overlay, and that the new product was designed to isolate the alpha component.

The firm is putting in place the necessary processes and safeguards to manage both the long and long-short legs of the strategy effectively, rather than opting for a safer, lower-risk SIF structure. The SIF structure offers mutual fund taxation while retaining some of the flexibility associated with alternative investment products. Sundaram argues that this gives it an advantage over portfolio management services, where the tax drag can become material over longer holding periods.