Smallcase : Is it big enough?

Smallcase is not a theme, innovation, strategy, process, or idea. It's a private limited financial services company. Let us understand in-depth about smallcase before we start investing.
Before we understand Smallcase, we need to be clear on the concept of Stock Basket, since this is the core of the services that this company offers.

What is a Stock Basket?

Stock Basket is a collection of stocks. Well, so is a stock portfolio. But there is a difference. The stocks in a Stock Basket are put together by following a specific, well-defined theme. A Stock Basket is made when two or more companies fall into a similar theme.

Let us understand this concept of Stock Basket through an example. A Stock Basket related to the housing sector will contain stocks of cement companies, tiles companies, paint companies, and a lot of other stocks which are related to the housing sector. The common theme of such a Stock Basket is Housing. 

But it does not have to be just a sectorial theme like housing, healthcare, or technology. The theme in a Stock Basket can have just any theme. 

As an example, the theme of a Stock Basket can also be on the basis of companies with similar fundamentals, companies with high growth prospects, dividend-yielding companies, companies impacted by government policies, etc. The theme can reflect any kind of idea.

What is a smallcase?

Smallcase is not a new technology, it's not innovation, it's not a platform. Smallcase is none of these. Smallcase is a company that makes Stock Basket for investors to invest in. Smallcase’s main aim is to make direct equity investment for retail investors easy. And ofcourse, like any other company, it will earn profits from its investors.

Smallcase makes these Stock Baskets based on different themes, ideas, and strategies. The underlying investment asset of these Stock Baskets is either Stocks or ETFs and sometimes both.

To a layman, a Stock Basket is no different from a Smallcase.

Origin of Smallcase

This Bengaluru-based startup was founded in 2015 by IIT Kharagpur graduates - Vasanth Kamath, Anugrah Shrivastava, and Rohan Gupta. Smallcase was started to introduce a new generation of investors to the Indian equity markets.

They received funding from HDFC Bank(in Dec 2020), DSP Group, Sequoia Capital, Blume Ventures, and many others.

Smallcase started in collaboration with Zerodha, the premier discount broker in India. That is why it was first called Zerodha Smallcase. Later, Smallcase added many other brokers to its list.

Who makes Stock Baskets in Smallcase?

Stock Baskets in Smallcase are made by SEBI registered financial experts and broking houses. Some big companies like HDFC AMC, ICICI PRUDENTIAL, AXIS SECURITIES, and others have joined Smallcase and have made some Stock Baskets of their own. Click here if you wish to see some of the creators of Stock Baskets on Smallcase.

How many Stock Baskets are there?

Theoretically, there can be unlimited stock baskets. Currently, there are close to 100 stock baskets managed by stock basket managers. The list of such Stock Baskets is ever-growing. One manager can handle more than one basket. e.g. Windmill Capital has 36 Smallcases (Stock baskets being managed)

Who handles the money?

One needs to understand that Smallcase is just a ‘middleman’ company or a broker, helping you choose the stocks or securities, based on a certain theme. Smallcase is in no way involved in handling your assets or your money. Up to this point, you might feel that SmallCases are hardly any different from mutual funds, but the devil is in the details, as you will get to know.

How many brokers does Smallcase Support?

Smallcase, at first, just allowed Zerodha as a broker to invest with. But now Smallcase supports 9 brokers with whom anyone can invest in Smallcase’s Stock Baskets. They are continuously adding new brokers to invest with.

List of brokers currently working with Smallcase:

5Paisa
Alice Blue
Axis Direct
Edelweiss
HDFC Securities
IIFL Securities
Kotak Securities
Trustline
Zerodha

How to open a Smallcase Account?

You do not need to open a separate account for accessing Smallcase. You just need a demat account with any of the 9 brokers that Smallcase allows to invest with. When you go to the Smallcase website, you will get a choice to log in via any of the brokers you may already be registered with.

Charges to use Smallcase

Of course, you get to shell out some money to start using their services. There are one-time fees associated with using readymade smallcases. For further orders in the same smallcase, no extra charges will be applicable. For example, to invest in the All-Weather Investing smallcase, or the Smart Beta small cases, you are usually charged Rs 50 + GST, For all other small cases (thematic/sectoral/model-based, equity & gold smallcase), you might be charged Rs 100 + GST. Of course, the prices can change over time.

This fee is just for offering you a bouquet of smallcases. And as you must be aware by now, when you invest in smallcase, you are actually investing in the underlying stocks. So, over and above these nominal one-time fees, standard brokerage charges are applicable depending on the broker. If HDFC Securities is your broker, then you have to pay the transaction fees and brokerage to HDFC (as you would do if you buy stock directly) along with small-case fees.

Smallcase Vs Mutual Funds

This is where it gets very interesting. It is very easy for investors to get attracted to anything new in the market. And Smallcase is no exception. You will start to hear noises like Smallcase is the next thing in the town, and they are far better than the traditional mutual funds. But hold the horses.

Mutual funds are market capitalization based (large-cap, mid-cap & small-cap, flexi-cap) or sector-based(ex Pharma, IT, Healthcare etc.). But smallcase enables you to invest in ideas. For example, one can invest in companies that are working towards affordable housing projects if the focus of the government is on providing affordable housing to all. The stocks can be of different market capitalization or sectors. The smallcase can allow you to invest only in dividend-yielding stocks etc.

The main difference between Smallcase vs Mutual Funds is OWNERSHIP. And this makes a hell lot of a difference.

Her is how the ownership differs in both cases.

In an investment done ‘via’ a Smallcase, you become a direct shareholder of those companies present in the Stock Basket. 

But when you invest ‘in’ a mutual fund, you are just buying the units of a particular mutual fund and not the stocks that make up the portfolio of the fund. So, you do not become a proud shareholder of a company when you invest in a mutual fund. 

Now, that you have understood the technicalities, let us see the pros and cons of each.

Pros of Smallcase

1/ A Smallcase enables you to invest in ideas e.g. only dividend-based stocks, while mutual funds allow very limited themes. But then, the investor needs to have enough expertise to understand what ideas are worth investing in, in the current market situation. If an investor does not have that idea, then however jazzy the concept of 'investing in ideas' may sound, this benefit hardly stands ground. Moreover, it may not take much for mutual funds to catch up on this.

2/ One can track & manage smallcase easily. One can add or remove stocks anytime with the ‘manage’ option. But then that is no different than having a trading account and buying or selling stock directly. Of course, in mutual funds, you may not have the flexibility to choose the underlying stocks in the fund. But then, if you had that flexibility in mutual funds, would you have the expertise to make the right decision at the right time? This benefit also does not stand ground unless ofcourse you are an expert investor yourself. Well, in that case, why Smallcase, why not direct stocks?

3/ Investing in Smallcase is safe. The reason is straightforward. When you invest in smallcase, money is debited from your trading account and stocks are credited to your Demat account. But then, if you are directly working with your trading account, this advantage gets nullified too.

4/ Unlike mutual funds, there are no expense ratios in a Smallcase. This is a big attraction for a lot of investors. This expense ratio is annually deducted from your investment and is around 1-2 percent of the investment. Of course, if you understand what themes to invest in, and what stocks to invest in, you may be better off investing directly in stocks.

5/ Transparency – Smallcase allows you to see what’s inside the portfolio at any given point in time. This is not feasible in mutual funds to a large extent. It is good to have visibility, but not sure how it really benefits a retail investor.

Cons of a Small Case

1/ The biggest disadvantage of Smallcase is portfolio rebalancing.

Smallcase regularly updates their Stock Baskets on the basis of the market conditions and when you invest through a Stock Basket of Smallcase, you are prompted through your broker to make the same changes on your portfolio. You can either accept to make those changes on your portfolio or you can decline the offer.

If you decline the offer, then you would derive sub-optimal returns. But if you accept to re-balance your portfolio, then Stocks or ETFs associated with the particular Stock Basket will be bought or sold according to the changes made in the Stock Basket.

Now, this is where the problem starts with Smallcase. This monthly buying or selling will cause your taxes to go up as you might be required to pay Short Term Capital Gains Tax (STCG Tax) on any stock sold within a year of buying. Not only the taxes, but these frequent transactions will also make your turnover cost go up with your broker since you would be transacting too often.

Take this. If any Stock or ETF previously present in your portfolio (prior to rebalancing) was in red, and if it was sold during the re-balancing act, then you have to carry the weight of the loss on your shoulder. You need to bear all this because, in a Smallcase, you are the "owner" of the stocks. Ownership makes a big difference.

On the other hand, when a mutual fund buys or sells any stock from its portfolio, the tax burden is not carried by the mutual fund unitholders, because you are NOT THE OWNER of the stock in this case.

Booking frequent gains and losses, transacting too often are not the only issues. The bigger issue is managing all this. A retail investor, who is already occupied in his job or business, is going to devote a significant portion of his free time to just get a grasp of how much taxes need to be paid, how can they be saved, etc, just because the necessary evil of portfolio balancing falls on your head, rather than the head of Smallcase.

2/ You cannot work on a smallcase without having a broker account in any of the above 8 listed brokers. On the other hand, mutual funds have no such restriction. All you need for investing via mutual funds is your KYC-compliant PAN Number.

3/ Smallcase does allow SIPs as an investment method, much like Mutual Funds, but falls short of providing the equally valuable SWP (Systematic Withdrawal Plan) and STP (Systematic Transfer Plan) options. This means that you may not be able to average out the returns at the time of exit, and therefore, you will be required to time the market at the exit - a phenomenon that is not yet mastered by anyone.

4/ The stocks from a smallcase are sold only based on the theme of the smallcase and not based on the performance. So, any stock that no longer fits the theme will be removed and any stocks that fit the theme will be added. This, the biggest uniqueness of Smallcase also becomes its big drawback since Mutual Funds would focus more on performance than on the perfect alignment towards a given theme.

5/ Total Investment minimum amount per smallcase is very high when compared to other modes of equities investments like ETFs, Mutual Funds, etc. For example, investing in a default Dividend Aristrocat smallcase requires Rs 43,000 as the minimum amount to be invested. While one can start investing with as little as Rs 500 in a mutual fund, this smallcase drawback may take away many small retail investors. The average minimum investment amount in a Smallcase is close to Rs. 50,000 - though tiny fractions (around 5%) of small cases do allow for minimum investment less than Rs. 1,000. It's quite understandable since, for a Stock basket of 30 stocks, you will have to buy at least 1 share of each company and if the average market price of the company's share is Rs. 1000, you got to invest a minimum of Rs. 30,000 (1000 x 30) to invest in the smallcase. On the other hand, mutual funds allow for buying fractional units, thus giving a distinct advantage to a small retail investor.

6/ All stocks in the smallcase are bought at the same time, irrespective of the current price. Typically, there is no value analysis to find the intrinsic value of the Stock Basket, and patiently waiting for the current price to fall below the intrinsic value. Thus small-case can never beat stock returns when done with value analysis.

7/ There is no clear idea behind the research team involved and whether the stocks included based on the rationale behind the strategy adopted was correct. When investing via smallcase, you must blindly believe in an idea/strategy/sector - relying on the smallcase research team's expertise.

8/ There is no support to rebalance all of your smallcase stock baskets at once. Different stock baskets get rebalanced at different times. In Stock Basket A, one stock could be sold, and the same stock could be bought in Stock Basket B. On the backend, this is like doing an intraday trader. 

9/ The fund manager in an actively managed mutual fund would take quick decisions depending on the market situation and expected performance of the underlying stock. In small-case, however, the suggestions would come only once a month - at a predetermined time, and even then, the option to implement the suggestion is with the investor, who, in most cases, would have no data points to take any kind of an informed judgment. In a volatile market, waiting for a month might prove to be quite detrimental.

Summary

The concept of a Stock Basket is still new to India. So, we might see more and more companies like Smallcase growing up here in India. Who knows that the next company may be named Largecase.

Though on paper, the concept of Stock Basket sounds fascinating, and it is to an extent helpful for retail investors, but the reality of investing through Stock Baskets is different.

Regular portfolio updates and re-balancing will take a chunk out of the investor’s profit in the form of taxes. And not to mention the loss borne by investors due to the selling of securities when they are in the red. The entire thing just adds too much taxation and complexity to your investment.

Smallcase might be a great tool to find new companies in different sectors and themes but it is not the right investment medium for direct equity investment. I would use Smallcase as a stock screener rather than an investment medium.

Regards

Manoj Arora
Official Website