Why's Tata's small-cap fund excelling? Fund manager explains

With a focus on growth at a reasonable price, Chandraprakash Padiyar has built his investment approach around three key pillars: consistent growth, free cash generation and favourable entry points. "Buying at the right price defends you from any volatility," explains the Senior Fund Manager at Tata Asset Management, who joined the AMC in 2018.

Overseeing the five-star rated Tata Small Cap Fund and the Tata Large & Mid Cap Fund, Padiyar has navigated four market correction cycles since 2018. His small-cap strategy has been particularly successful, growing from Rs 190 crore to Rs 8,710 crore while maintaining its focus on relatively smaller companies compared to peers.

In this conversation, Padiyar shares insights on his investment philosophy, discusses how he's managing the growing AUM of his small-cap fund and explains why he believes the market is shifting back to a stock selection philosophy after two years of momentum-driven behaviour. Below is the edited transcript of our discussion.

How would you define your investment philosophy? What types of stocks or market trends excite you the most?

Our investment philosophy is growth at a reasonable price (GARP). Since India is a growing economy, we look for growth in your portfolios. That said, consistent growth is more important for us than short-term growth.

So the basic idea is, can a business scale over a period of time, or can a management team running a business do something in their business that can help them scale consistently over a period of time? Secondly, we not only want growth, but we also want growth with free cash generation. We believe that businesses that can generate free cash flows over a period of time are the businesses that the market tends to rerate. You don't see too much volatility in stock prices in such businesses. Third, we focus on growing companies that are available at a reasonable price. For us, a reasonable price is the starting point when we buy stocks, as valuations should be in our favour. Buying at the right price seeks to defend you from any volatility.

In fact, one thing that we do in our research process is that whenever a business idea comes up for discussion, one question that we ask is what the downside is in that stock price. So, the entry point or buying the stocks is critical for us, and a reasonable price is what we look at. Suppose the management delivers earnings over a period of time with excellent growth and free cash generation. In that case, those valuations that today look reasonably priced or expensive will look cheaper over the next two to three years, and you can get a rerating of valuations. So early investing, or, as one can say, contrarian investing, is what we are looking at in various companies and management.

The performance of your small-cap fund has been solid across time periods. It has also held up well during recent market volatility. What has been working well for you?

We launched this fund around September 2018, and in these six years, we have seen four cycles of short and long corrections.

As discussed above, our investment philosophy has helped us a lot because we've been able to identify growth companies with consistently growing businesses that generate free cash. The balance sheet quality is forceful, and lastly, our starting valuations or price points at which we bought the business have been favourable enough that our risk has been lower.

Since we are early investors, we bought businesses when nobody wanted to look at those companies. Naturally, risks are involved, as any miscalculation in earnings can result in significant losses. Fortunately, I would argue that luck has also played a significant role over the past six years. The companies have delivered growth and earnings in line with or better than what we expected in most cases.

Your small-cap fund maintains a true small-cap focus, investing in relatively smaller small-cap stocks compared to peers. Do you see rising AUM becoming a constraint at some point? At what AUM level would you feel uncomfortable managing liquidity and staying true to your strategy?

The first point to note is that when I began managing this fund in 2018, the market capitalisation of 251 small-cap companies was only Rs 6,000 crore. Now, it is around Rs 32,000 crore, so the market has expanded fivefold.

One good thing about the Indian market is that our economy and businesses are growing, and the value of businesses will continue to increase over time. So, the market helps the fund manage larger assets under management (AUM). We started the fund with Rs 190 crore, which is now over Rs 8,710 crore (monthly average AUM for February 2025) and given the liquidity profile and the granularity of the portfolio, I'm relatively comfortable managing the risk profile from a liquidity perspective.

Since June 2023, we have stopped taking lumpsum flows in the small-cap fund, and inflows are only allowed through SIPs and STPs. I think that's the right way to go over a longer period of time because you grow in line with the market valuation rather than growing your AUM disproportionately larger in a short period. This approach helps manage the issue. But if my fund doubles in size tomorrow, I may also have to choose to buy large caps and mid caps, which are allowed up to 35 per cent of AUM as per the scheme features. A small-cap fund manager can buy 35 per cent of the fund in other than small caps, and a minimum of 65 per cent has to be in small caps. Most of my peers have chosen to do that until now, as most of the small-cap funds in the industry do have around 25-30 per cent in large caps and mid caps as well to manage liquidity. As of now, we are choosing to continue to be small caps because, at this size, we believe that we can manage our liquidity.

While the Small Cap Fund is in the top quartile, how do you plan to improve the Tata Large & Mid Cap Fund, which is currently in the second quartile?

If you observe the performance of large- and mid-cap stocks, you will realise that the performance was poor in calendar years 2023 and 2024. However, in 2025, we rebounded and are performing well.

Now, if you look at 2023 and 2024, the market was momentum-driven. It was broad-based, and portfolios with a larger number of stocks performed better than those with fewer stocks. At that time, stock selection and earnings did not matter. It was a P/E rerating market, and many businesses started trading at 100 P/E and 200 P/E as well. So, our market was exuberant, whereas our investing philosophy was to invest in growth at a reasonable price.

During those two years, we avoided all of those names that were high-flying or good-performing companies in the market. In the process, we paid a price in terms of lower relative performance. Obviously, it still looks lower on a one-year basis because it's just two months of consolidation correction in our market. We believe that on a long-term basis, earnings are more important than stock performance, and P/E rerating at a point stops. You can't consistently get high returns purely on P/E rating; you have to get support from the earnings.

Our view is that incrementally, starting this year itself, the market is shifting back to stock selection. The focus will be on earnings deliveries, which means that any portfolio that is very choosy and selective and has businesses that will deliver positive growth should hopefully continue to do well.

Small-cap stocks have experienced a steep correction in the last six months, with the index falling around 23 per cent simultaneously. Are valuations now reasonable, or is there room for further correction?

It is a mixed bag. In some parts of the small-cap universe, we still see valuation being on the higher side, whereas there is a part where valuations have become quite attractive. Nowadays, I find companies trading at 5-6 P/Es and also discover companies trading at 40-50 P/Es. I find high P/E stocks in the benchmark index, such as the NSE Smallcap 250 index, and that is why we believe it makes sense to invest outside the benchmark, which is why our active share is higher.

Selective companies may be growing at a CAGR of 20 per cent on earnings over the coming years. At the same time, there will be many companies growing at 10-15 per cent as well, and it will be strikingly different from the last four years when, across the board, the companies grew by 25 per cent in the small-cap segment.

You may have chosen or been less selective in businesses in an environment where companies grew rapidly year after year. But now I think that we have reached that point where a limited number of companies will be able to deliver higher growth on the base at which they have reached in the last year. So when this happens, selecting the right business will be important, rather than being in a higher sector or choosing which sector to allocate more. This is why we believe we are back to a stock selection environment in our economy or market. We hope that this will help us going forward.

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