Insider trading, nanocaps and happy hours: smallcase managers try offbeat ideas

Smallcases are simply baskets of stocks or exchange-traded funds (ETFs), created to offer an investment idea.

Back in 2016, when smallcase was launched, it used its own research arm to build and create baskets of stocks and ETFs, but today several research analysts and investment advisors are offering investment ideas through smallcases. There are more than 150 smallcase managers that have mushroomed over the years.

From microcaps to insider buying, to post-Covid-19-revenge consumption, here is a look at some interesting investment ideas created by smallcase managers.

Spotting ideas among microcap stocks

Hyderabad-based Abhishek Banerjee along with his co-founder Dr. Prachi Deuskar, who is professor at Indian School of Business (ISB), founded LotusDew Wealth in May, 2019.

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Banerjee has in the past worked as a portfolio manager for the $180 billion Netherlands sovereign wealth fund MN and worked at Franklin Templeton in their hedge fund business, working on their multi-asset long-short hedge fund strategies, quantitative investment strategy, apart from fund selection. Banerjee also holds a degree in computer science engineering. He has done his MBA from Rotterdam School of Management and Duke University, USA.

Listed Venture Capital and Nanocap Champs are two microcap focused strategies launched by LotusDew Wealth in 2019 and 2021, respectively. Microcap stocks are stocks that are even smaller than small cap stocks in terms of market capitalisation.

Banerjee with the help of his programming and coding experience has built AI-algorithms that run through the stock market universe and aim to identify microcap companies with better corporate governance and management quality.

Their algorithms map board members of the microcap companies, with the other listed companies to check if the same board members are part of these companies. Also, the algorithm tries to identify the schools they have passed out from, their batchmates, “to understand the kind of people associated with this person and the companies associated with this person,” Banerjee says.

“Generally, people with high reputation will only associate with people, who also come with high credibility. By tracing these relationships, we look for whether these people with perceived high-credibility who are on board of large companies, are also on board of smaller companies. This first-stage of screening itself narrows down our search to a great extent. From say 2,500 stock universe to about 100,” Banerjee adds.

This follows another set of rigorous filters. LotusDew uses natural language processing (NLP) to check tax litigation history through the company annual reports. AI is used to analyse top-line trajectory, consistency of profit margins, one-off item on balance-sheet, tax payment history, etc. “We are trying to avoid companies that appear to be gaming the system,” he says.

There are other checks as well. “We check for whether most of the board-members have similar surnames. If that’s the case, it may be an indication that the board’s independence is compromised. How many geographical locations they are operating in? The more locations the company is operating in, the harder it is to fudge the system,” he points out.

Listed Venture Capital has delivered 51% compounded annual returns in last three years. In absolute terms, it is 237%. Nanocap Champs has delivered 27% returns (in absolute terms) since its launch in September 27, 2021.

Looking at insider trades for buying cues

Top 10 Insider Trading is a smallcase that looks for buying opportunities by tracking buying trends of the promoters.

Built by Mumbai-based Nooresh Merani, who has 15 years of experience in markets as technical analyst, trader and later as investor, the smallcase looks for large quantum of promoter buying in a company and then invests in such companies.

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“Usually when there is promoter buying, that money tends to stay there. This is because if promoter starts selling, it is perceived very negatively by the markets. So, in most of the cases, it’s a one-way street,” says Merani.

The smallcase can only buy companies where there has been insider trading activity. So, that itself narrows down the investable universe for this smallcase.

Merani also checks whether the insider buying and selling is just an inter-promoter transfer. “So, we look for odd-share size. Usually, when there are multiple entries of same quantum of shares, these are just transferring of shares from one promoter to another,” he says.

Some of the names that are part of Merani’s portfolio are Maharasthra Seamless, Man Infra and Mazda, where there have been strong promoter buying.

Merani and his team go through the insider trading data that is disclosed on the Bombay Stock Exchange (BSE) at the end of every week. “However, we don’t churn our portfolio too often, maybe we would replace one or two names in the top-10 portfolio once in a quarter,” he says.

This smallcase is focused on small cap companies. Merani says he is well-aware of the corporate governance risks that come with small caps, but he is now well-experienced to pluck out the bad apples.

The Top 10 Insider Trading smallcase has delivered returns of 43% (in absolute terms) since its launch in August 2021.

Finding beneficiaries of post-Covid-19 world

Mumbai-based Dick Hosy Mody has 30 years of experience in the capital markets. In the first 25 years, he has worked on the institutional broking side at various global investment banks (JP Morgan, Morgan Stanley and Deutsche), advising global money managers on their Indian equity investments.

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In 2016, he founded Ethical Advisers as a wealth management advisory. Ethical Advisers started with smallcase offerings in 2020 with five portfolios, and now offers 20 theme-based smallcases.

“We started our smallcase journey after Covid-19 broke out. We sensed some macro thematic opportunities back then, as valuations in several sectors had taken a heavy beating and launched metals, financials and auto themed smallcase around that time,” Mody says.

Happy Hours: Cheers to Good Times was launched in 2021 after first wave of Covid-19 had peaked out. Mody says it was launched to capitalise on the pent-up demand coupled with unspent cash with investors that had piled up due to Covid-19 lockdowns.

“There had been lot of pent-up demand when it comes to travel, hospitality, leisure. And we foresaw a massive trend of revenge consumption in the post-Covid-19 world. We took a cue from this trend playing out in US economy first,” Mody points out.

Ethical Advisers follows fundamental analysis. “First and foremost, we identify a theme that we want to focus on.”

Then the universe is narrowed down to 20-25 names. Within this universe, companies are analysed on their balance-sheet strength, dividend track-record, earnings trajectory. Mody uses his experience as an investment banker to screen out companies that might have promoter-led issues or weaker management, and the universe is further narrowed.

Since its inception in June, 2021, the smallcase has delivered returns of 55% in absolute terms.

Tracking insurance

Smallcase itself had its own products team that developed several smallcase strategies after it was set-up in 2016.

In the initial days, smallcase’s team started with sector and theme-focused smallcases and that’s when Insurance Tracker was launched. “We realised that there were not too many exchange traded funds (ETFs) back in those days that tracked sectors and even the sector indices were market cap-weighted. So, we started launching smallcases to offer low-cost alternatives to investors, with portfolios built to better-represent the sector,” says Naveen Kaushik Rajan, assistant vice-president, investment products, Windmill Capital.

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In 2020, smallcase’s products team was carved out into a separate entity – Windmill Capital.

The investment process starts with looking at all the insurance companies. The companies are vetted on Windmill’s internal quality score, which is like a hygiene check that gauges the company’s management effectiveness and earnings variability. “We also check for things like promoter pledging and whether there is adequate liquidity in the stock,” says Rajan.

Once all this is done, the investable universe is ready and then companies are analysed to assess their fundamental strength and weakness. Windmill Capital has a research team of six analysts and widest range of smallcase strategies at 53.

The Insurance Tracker is yet to deliver as it is down 16% in three-year period. Since inception, it has delivered just 1% returns.

What investors should keep in mind?

While smallcases offer a diversified portfolio, it may not be as diversified as mutual funds. A more concentrated portfolio might potentially offer higher returns, but also see sharp declines if market conditions are not favourbale.

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Smallcases get re-balanced as and when the manager thinks that a stock needs to be excluded or included in her portfolio. The alert is sent to the investor and it depends on the investor whether she decides to re-balance or not, in-line with the manager’s decision.

When the re-balancing involves selling, this may attract capital gain taxes.

Smallcases come with subscription fees. The returns shown on smallcases’ website don’t account for the fees charged.