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Mutual Funds versus smallcase: Key Differences ๐Ÿ‘ฏโ€โ™‚๏ธ

Mutual Funds Sahi Hai! But there is a promising challenger coming up, and thatโ€™s smallcase. What is a smallcase? They are just baskets of stocks and/or ETFs that are professionally managed. There are some other players too like WealthDesk, which have similar offerings.


Professional managers build baskets of securities, and you can invest in them by simply linking your broking account, and buying them all together, as advised by the managers. Mutual funds and smallcases are both diversified portfolios, and achieve the need for investors to build robust long-term strategies. But there are key differences in how they are structured, built and rebalanced.


Here are the key differences between the two:


1. Structure


A mutual fund is a pool of money collected from investors, which is then invested in securities like stocks and bonds. Since the pooled money is invested, it can be further broken down into units, which investors can purchase. This structure helps reduce the overall investment requirement. Rather than taking exposure to all the stocks and bonds individually, through a mutual fund, investors can instead take exposure to units of the fund at a much lesser cost.


On the other hand, a smallcase would enable to you to directly own stocks, and not units. This would mean, you hold the stocks directly, and have to buy them in full. Essentially, a higher minimum investment amount.


๐Ÿ… Mutual Funds


2. Control


smallcases offer better control of your investments since you hold them in your demat account directly. The portfolio is at your fingertips, ready for you to modify, or sell whenever you feel right. This also means you can customise your portfolio, and not strictly follow the advice of the manager.


In a mutual fund, you hold units of the fund, and not stocks directly. The mutual fund units may or may not sit in your demat account, depending on which platform you have used to buy them. You also lose the ability to customise anything, or redeem units and get your money as quickly as you can by selling stocks.


๐Ÿ… smallcase


3. Diversification


Mutual funds usually hold 50-100 stocks, whereas smallcases hold much lesser. The fact that the minimum investment amount increases in smallcases restricts managers from adding a large number of stocks.


But thereโ€™s another angle to this - through our research, based on quantitative and empirical data, we see that volatility reduces by very little after 15-17 stocks. The addition of each new stock in your portfolio after that would reduce the volatility by lesser and lesser, diminishing the benefit of diversification, and in fact also reducing the benefit you could derive from stocks materially going up (because of lesser weight).


Mutual funds hence may be over-diversified to a very large extent.


๐Ÿ… Mutual Funds


4. Minimum investment amount


The mutual fund structure allows for the minimum investment amount to be as low as Rs. 100 or even Rs. 500.


However, since full stocks have to be bought in smallcases, the minimum investment amount is larger. This will vary from smallcase to smallcase depending on the manager, the theme of the smallcase, the value of stocks in it, the target market of the smallcase manager, etc.


๐Ÿ… Mutual Funds


5. Returns


Both mutual funds and smallcases are managed by investment professionals. However, over-diversification can lead to lesser returns (and lower volatility) in the case of mutual funds.

If a mutual fund holds 50 stocks, and a particular stock has 2% weight, it doubling will only result in a 4% return addition to the fund. However, in a smallcase that holds 10 stocks, the same stock can make a difference of up to 20%.


Do note though, that this would also mean higher volatility for the smallcase, in the near-term.


๐Ÿ… smallcase


6. Volatility


Because of over-diversification, mutual funds would typically have lower volatility compared to smallcases. However, this stands true only for smallcases that are made up only of stocks.


In the case of ETF-based smallcases, the reverse can also be true. Take Rupeetingโ€™s Core smallcases for example. They are made up of 5-6 different asset classes, which makes them very low on volatility, while exceeding in terms of returns, compared to indices.


Another point to note on volatility is that for a long-term investor, interim volatility shouldnโ€™t really matter. Over the long-run, higher returns can make up for the disadvantage of higher volatility.


๐Ÿ… Mutual Funds


7. Management fees


Mutual fund fees are capped at 2.5% of the amount invested.


smallcases donโ€™t really have a range, for the sake of simplicity. Some managers charge a fixed fee per month, whereas some charge basis the amount invested.


Rupeeting charges 0.5% per annum on the Core Portfolios and 1.75% per annum on Equity Portfolios.


๐Ÿ… smallcase


8. Cost of exit


Mutual funds typically charge a 1% exit load on investments, if they are withdrawn before 1 year of investing.


smallcases donโ€™t usually charge any such amount. There essentially is no lock-in period or any fees associated with an early exit making smallcases more flexible and cheaper to exit.


๐Ÿ… smallcase


9. Transparency


With mutual funds, portfolio disclosure is a monthly affair. In the interim, you wonโ€™t have access to the holdings of the mutual fund, and of the additions, reductions, and modifications to the portfolio. In short, you have to trust the mutual fund blindly.


In smallcases, you have access to your holdings in your demat account. Moreover, at each rebalance, you approve the transaction, which ends up in you being informed about the changes. Several managers will also publish research at rebalances explaining what they are doing and why.


๐Ÿ… smallcase


10. Effort of operating


Investing in mutual funds is easy. You just put your money in, let the AMC do its job, and redeem it whenever you want.


With smallcase, once you decide to buy a smallcase, there may be additional steps like connecting your broking account, adding money into it, authorising trades and making sure they are executed per the advice.


Even on rebalancing, you would have to approve the rebalance, and authorise trades, and make sure they are executed.


๐Ÿ… Mutual Funds

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