An Emergent Opportunity

Could smaller businesses be on the cusp of becoming the next big money spinner for the Indian equity investor? There are a number of indications that this may well be the case. On the aggregate level, smaller companies tend to outperform larger companies. Over a long period, globally, this is clearly visible in the movements of indices like the MSCI World Indices. Can Indian investors exploit this opportunity? Can they identify the right way of doing so. Let's examine the issue in greater detail.

Generally, Indian investors have tended not to approach equity and equity fund investing from this perspective. When they have to evaluate equities or equity-backed investments like mutual funds, many investors make the mistake of focussing too much on which sector or industry a company operates in, and focussing too little on company size.

This often results in investors following strategies that fail to bring to them the benefits of investing in emerging businesses. Emerging companies are inherently different from larger, more established ones, and this is something that investors appreciate far less than they should. Sectoral focus is important And yet, the fact is that while a large auto company will have some things in common with an emerging auto company, the smaller one will also have many things in common with another emerging company.

Even if two companies are in the same industry and have the same general type of business, emerging companies will have some big differences from larger companies. These differences arise both from fundamentals-the nature of the business-as well as how the stocks behave. In both, the big difference arises from a higher rate of change.

Smaller companies tend to be more volatile, but this can be a challenge, as well as an opportunity. The simple fact is that emerging business offer higher opportunities, as well as challenges that can be tackled by good quality investment management. Obviously, a good emerging business can grow faster, or decline faster. It can take advantage of a changed business situation better and grow rapidly, or be unable to cope with changes and decline rapidly. Something similar happens at the level of their price movements in the stock markets.

An emerging business will typically (though not always) have a relatively lower trading volume and a smaller number of traders-large or small-interested in it. This means that one, any given piece of news, positive or negative, can affect its stock price much more sharply than an equivalent news would a large cap stock. It also means that much less research attention is paid to these stocks. The said good news can go past without being noticed and without having much impact on the stock price.

For you, as an investor, this boils down to higher potential gains, and higher potential losses if the right kind of attention is not paid to these investments. In other words, these offer returns with the potential to outstrip larger, more established stocks.

However, the research challenges are formidable. There are a large number of smaller companies that can potentially qualify as high-potential emerging businesses, but weaning out the real winners require a dedicated and professional research effort which is hard for an individual to manage. Unlike large and established companies, for which deep information is publicly available, and investor would really have to dig deep into smaller businesses to identify the real emerging businesses.

This is the kind of research that makes it imperative that investors exploit this opportunity by choosing a good fund rather than dabble in these stocks himself. Emerging businesses are a great opportunity for investors to make long-term investments that will fetch outsized returns. However, as we've seen above, it's hardly the kind of investment where anyone can hope to go it alone. Choosing the right fund, and taking advantage of the professional research and investment management that a fund provides is a crucial part of exploiting this opportunity.