Fund managers scour for small firms with sound business models.

Fund managers are now exploring investments in smaller unlisted companies, betting on their attractive business models and growth potential.

Mutual fund investments in unlisted firms have stayed negligible even though regulations permit them to invest up to 5 per cent of an open-ended equity scheme’s corpus in unlisted equity shares or equity-related instruments. Closed-ended funds are allowed to invest up to 10 per cent of their corpus in such companies.

Industry watchers said after the dotcom bust in 2000, which saw fund houses suffering huge losses owing to a huge exposure to technology companies, fund managers kept off unlisted companies.

“With a large number of closed-ended funds being launched, fund houses can examine investing money in unlisted companies, which have a robust business model. Fund managers could bet on growth potential of these firms, as they have a three-year period to nurture the portfolio,” R Swaminathan, national head (mutual funds) of IDBI Capital, said.

Recently, DSP Merrill Lynch launched a closed-ended equity fund aimed at investing in micro firms, whose market capitalisation was less than Rs 1,500 crore. The fund house expects to raise around Rs 500 crore from the scheme and 65 per cent of it would be invested in small-sized young firms.

About investments in unlisted companies, S Nagnath, president and chief investment officer, said the fund house would consider such investments, as per the regulator’s norms.

Sameet Kamdar of Mata Securities said the industry had matured a lot compared with the dotcom period. “At present, there are around 10-15 funds especially dedicated to small- and mid-caps, which means the industry has enough expertise to judge these small companies, which are attracting much attention from global PE players. So, funds could utilise this limit,” he said.

The country’s oldest and third largest fund house, UTI, with a corpus of Rs 35,517 crore, has invested just 0.07 per cent of its corpus in smaller unlisted pharmaceutical, automobile, media and software firms.

“Investing in unlisted firms is both beneficial and risky. It is risky because unlisted companies impact NAV calculations adversely. However, there are unlisted firms in emerging and existing sectors that offer strong growth opportunities in 1-3 years. Funds can look at such companies selectively at an attractive valuation at a pre-IPO stage,” the fund house said in an emailed reply.