Crowded names would likely struggle to absorb indiscriminate selling pressure

As this calendar began, the median Indian small-cap mutual fund’s book (ex-financials) was priced at 27x F2025E (Mar) EBITDA, with the overall fund category ranging from 18x to 38x. For context, Nifty Smallcap50 (ex-financials) began the calendar at a materially lower 23x, while supposedly “reasonably valued” Nifty50 (ex-financials) was priced at just under 24x. It is worth noting that given that half or more of these benchmark components were net-cash names, even clearly poor valuation multiple optics concealed real valuation excesses here. Minerva India Under-served meanwhile began the year at about 11x F2025E (Mar) EBITDA.

While short-termism and naivete are often associated with retail investors, we have consistently argued that the current group is likely also the most entitled we have seen in more than quarter of a century. The crammed herd we have seen over the past couple of years strongly reflects a near blind ongoing obsession with current visible growth, with little debate around sustainability of that growth or associated operating returns. When such heady growth ebbs (and it always does), the associated cuts in heady multiples result in a painful one-two gut punch.

As the year started, underlying holdings of Indian small-cap funds were significantly more skewed towards small-cap stocks, than the regulator mandated thresholds require. For context, Indian regulator allows a mutual fund to be categorized as a ‘small-cap fund’ as long as at least 65% of the book is allocated to small-cap stocks. At the beginning of this year, ~81% of India’s small-cap fund category’s equity allocation was in small-caps (see the attached exhibit). By our estimate, that’s nearly INR 500 billion (50K crores) more than the mandated minimum. Put another way, that’s about 3 calendar quarters worth of the net inflows that the entire category received in January 2025. Accordingly, even assuming that the January level of net inflows continue, presumably a sanguine assertion, it is likely that these flows are increasingly allocated away from small-cap stocks. Expectedly then, this would allow for even less buying to absorb the potential retail brain-freeze elsewhere within individual brokerage accounts. Add potential fund redemptions, and it could get uglier (and ugly is immensely beautiful to us), before it gets better. We strongly suspect that the extent of security-specific crowdedness could increasingly dictate a chaotic ticker tape.

For further information, please reach out to Arpit Khunteta or Devchandra Ramani.

DISCLAIMER: The information, opinions, estimates and projections contained in this note were prepared by managers of Minerva India Under-served and constitute its current judgment as of the date of this note. The information contained herein is believed to be reliable and has been obtained from sources believed to be reliable, but we make no representation or warranty, either expressed or implied, as to the accuracy, completeness or reliability of such information. We do not undertake, and have no duty, to advise you as to any information that comes to our attention after the date of this fund brief or any changes in its opinion, estimates or projections. Prices and availability of securities are also subject to change without notice. This is not a prospectus and does not constitute investment advice or an offer or solicitation to buy or sell any designated investments discussed herein. Neither Minerva Asset Advisors, nor its officers, directors, agents, or employees make any warranty, express or implied, as to the suitability of any fund as an investment or of any kind whatsoever, or assumes any responsibility for, and none of these parties shall be liable for, any losses, damages, costs, or expenses, of any kind or description, arising out of this newsletter or your investment in any fund. You understand that you are solely responsible for reviewing any fund, its offering and any statements made by a fund or its manager and for performing such due diligence as you may deem appropriate, including consulting your own legal and tax advisers.