Avoid Chasing Small-Cap Outperformers; Valuations Look Attractive for Long-Term Investors: Pratik Dharmshi, Union MF

Pratik Dharmshi Remains Positive on Small Caps

Pratik Dharmshi, Fund Manager – Equity at Union AMC, said the risk-reward equation across market capitalisations has become more favourable as earnings growth shows signs of recovery and valuations have become more reasonable.

He said the investment approach remains focused on identifying quality businesses with healthy medium- to long-term earnings growth rather than simply following recent market performers.

Why Investors Should Avoid Chasing Recent Outperformers

Dharmshi cautioned investors against selecting stocks or funds simply because they have delivered strong recent returns.

According to him, investors should assess a company's valuation in relation to its expected earnings growth, along with business quality and return ratios.

The approach focuses on identifying fundamentally strong businesses that could potentially sustain earnings growth over the long term rather than chasing stocks that have already outperformed.

Small-Cap Valuations Have Become More Reasonable

Dharmshi said valuations in the small-cap segment have become more reasonable, while earnings growth has continued to improve.

He described the current long-term risk-reward setup as favourable based on Union AMC's proprietary Fair Value Spectrum, which he said currently places the market in the "Very Attractive" zone from a long-term perspective. This is the fund manager's assessment and should not be interpreted as a guaranteed market outcome.

Which Sectors Look Attractive?

Dharmshi said Union AMC's sector allocation remains dynamic and is driven by earnings growth, valuations and industry cycles.

He identified capital goods, healthcare, capital markets, precision engineering and contract development and manufacturing organisation (CDMO) businesses as areas where the fund house currently sees attractive opportunities.

The approach is based on a bottom-up assessment of individual businesses rather than simply allocating capital based on recent sector performance.

What Does Union Small Cap Fund Look For?

Dharmshi said the investment philosophy focuses on businesses with:

• Strong growth potential

• Healthy return ratios

• Robust balance sheets

• Leadership positions or potential to gain market share

• Large addressable markets

• Capable management teams

• Strong execution capabilities

He said disciplined stock selection remains particularly important in the small-cap segment, where the objective is to identify companies capable of compounding earnings over the long term.

Liquidity Is a Key Risk in Small-Cap Investing

One of the major risks highlighted by Dharmshi is liquidity.

Small-cap companies can have lower trading volumes than larger companies, which can make buying or selling shares more difficult during periods of market stress.

Dharmshi said Union Small Cap Fund considers liquidity along with stock and sector diversification before taking a position. The fund manager said this approach is intended to help the portfolio navigate periods of volatility and sharp market corrections.

What Investment Horizon Should Small-Cap Investors Consider?

Dharmshi said investors should not allocate to small caps solely in pursuit of higher returns.

Because volatility is an inherent feature of the segment, he suggested approaching small-cap investing with a long-term horizon of at least five to seven years.

He also said investors should focus on their long-term financial goals instead of setting short-term return expectations.

Small-Cap Outlook for the Next Three to Five Years

Dharmshi remains constructive on small caps over the next three to five years, citing improving corporate earnings, economic growth and opportunities emerging across sectors.

At the same time, he acknowledged that periods of volatility are inevitable. His view is that investors with longer horizons should focus on quality businesses rather than attempting to identify the next short-term outperformer.

What Should Mutual Fund Investors Keep in Mind?

The comments highlight an important distinction between past performance and future potential.

A small-cap mutual fund or stock that has recently delivered strong returns may already reflect higher expectations in its valuation. Investors therefore need to consider portfolio quality, earnings prospects, valuations, liquidity and their own risk tolerance.

Small-cap funds are generally suited to investors who can tolerate higher volatility and remain invested for longer periods.

Key Takeaways

• Union AMC's Pratik Dharmshi remains constructive on small-cap equities.

• He said small-cap valuations have become more reasonable.

• Investors should avoid chasing recent outperformers.

• Quality businesses and sustainable earnings growth remain key selection factors.

• Capital goods, healthcare, capital markets, precision engineering and CDMO businesses are among the areas he currently finds attractive.

• Liquidity remains an important risk in small-cap investing.

• Dharmshi suggested a five-to-seven-year or longer investment horizon for small-cap exposure.

• His views are his own and do not guarantee future returns or represent investment advice.