There are two parts to investing via smallcase:
the tooling around managing a watchlist of stocks, which enables us to execute transactions at portfolio level rather than at scrip level
the basket of stocks offered by smallcase themselves, such as the Low Risk - Smart Beta smallcase, which can have a collection of stocks, ETFs, commodities etc.
There's no doubt that the usability of smallcase, as a tool, to manage a stock portfolio is quite good. When we say "usability", we mean the user experience of using the smallcase website and its aesthetics. If you already have a plan to invest in a collection of stocks of your choice, you can create a watchlist and place orders using smallcase.
The second aspect requires smallcase having a proven track record. The people responsible for maintaining the various basket of stocks on their platform should be capable stock pickers themselves.
We're mostly concerned with the second aspect in this article.
Depending on the portfolio turnover, there can be significant tax drag for you since you'll be buying and selling units regularly.
Smallcase is typically known for rebalancing their portfolios once every 90 days, for most of the portfolios.
The act of rebalancing could result in some stocks being sold from your smallcase portfolio, which would also attract various charges associated with selling a stock.
Since these are all negative cashflow transactions in your portfolio, your portfolio XIRR would end up falling behind the advertised CAGR of the same smallcase, over the same time period.
There's a lack of a proven track record that can be independently audited and verified.
Asset Management Companies (AMCs) are legally required to publish the Net Asset Value (NAV) of their mutual funds everyday, and the list of holdings held by their mutual funds every month. This means that an AMC can’t give you random numbers. They are forced to keep everything in the public’s eye. This is not true for smallcases.
Smallcase is selling Backtested Models.
Backtesting needs to be free from various biases, such as look-ahead bias. Strategies derived from a backtest would always show great results when simulated over the same time period.
It’s hard to say if that’s what’s happening here; but since the appropriate data and disclosures around their modeling and backtesting is not present in the public domain, it makes sense not to just take them at their words.
There used to also be some concerns around smallcase not being upfront with some of their numbers. They include backtested portfolio in computing returns of the smallcase, which is not at all how any asset management services report their returns.
According to their recent blog post, they’ve updated some of their reporting to exclude such misleading data that could have potentially enticed curious investors to invest in hopes of high gains.
Finally, keep in mind that past returns are not indicative of future returns; and asset returns can be very different from portfolio returns.
A good investment is an outcome of a fact-based logical process. It should be rooted in better reasoning than just reported past performance of the asset.
Here are a few bars that the baskets of stocks offered by smallcase has to meet for it to be an investment worth considering:
Disclosure on Insider Holdings
It’s easy to trust an asset if the entity offering it themselves believe in the same, and invest in it.
Smallcase should, ideally, indicate net insider holdings against each basket of stocks that they offer on their platform.
Anyone can come up with a portfolio of stocks. However, if people from smallcase showcase that they're investing in their own basket of stocks offered on their website, it’d engender more trust in smallcase. A commonly accepted qualitative metric of mutual fund selection, is to look at key insider holdings — after all, why would someone else invest in a basket of stocks, if the entity offering it cannot get their own employees to invest in those? AMCs have to disclose insider holdings in their mutual funds as a percentage of net AUM to show how key insiders are invested in those.
This clarity is need of the hour.
Disclosure on Portfolio XIRR
Smallcase Baskets, by design, are a product where return difference due to both behavior gap and costs can be very high. They're not a standard buy and forget product.
Behavior gap is a well-defined term. In short, it denotes the difference between underlying asset’s returns, and returns as investors see in their portfolio, due to behavioral reasons.
This is a well-known phenomena in investment, and various firms over the years have published studies on anonymized bulk data, that even when assets perform decently, most investors who invested in those assets, over same period of time, wouldn’t see those returns in their portfolio. It’d be significantly lower.
A mutual fund is structured as a trust, so rebalancing doesn’t create any tax events for end investors who are invested in the same mutual fund. As for costs of STT, brokerage, and other fees associated with selling; all covered under expense ratio of the fund, which would be minuscule on a per-investor basis.
As discussed above, mutual fund NAVs are already post-cost, therefore so are the returns.
In addition to reporting CAGR of the portfolio, one should also expect to see on an average how a typical investor’s portfolio has performed, after costs, in that smallcase basket.
Publishing these numbers would only make it easier to trust smallcase that they have the best interests of investors in mind.
Disclosure on Portfolio History
Due to periodic rebalancing, the latest version of stock portfolio of a smallcase basket won’t be how the same as it was a few months ago. It could even be wildly different from how it was a few years ago.
If they were to publish stock portfolio history of their own smallcase baskets independently, it gives an investor an opportunity to validate:
whether the smallcase basket in question has stayed true to its mandate or not, as the theme of the smallcase basket dictates
whether the actual computed CAGR of the smallcase basket matches the CAGR advertized on the smallcase website
TL;DR: use the product if you like its usability; but not because you think their investment advice alone would make you great returns.
When using the smallcase website, you should use it as a tool to narrow down a watchlist of stocks and then do your own due diligence into underlying companies before investing in them.