In a year marked by high volatility and one of the biggest corrections in recent small-cap history, generating outperformance was no easy feat.
However, the Qode Growth Fund It managed to do just that – beating its benchmark by over 14 percentage points during the sharp sell-off in Q4FY26.
In this edition of ETMarkets PMS Talk, Rishabh Naharpartner and fund manager at Qode Advisors, deciphers the strategy behind this resilience – of a disciplined focus on quality and value investment to a systematic approach derivative products an overlay that helped limit downside risks.
He also shares his views on small-cap valuations, portfolio positioning and why periods of market stress often present the most attractive opportunities for investors. long term investors. Edited extracts –
Q) Please take us through the FY26 performance?
A) Exercise 26 was a story of two halves. The first half of the year was marked by high valuations and selective market participation, while the second half, particularly the fourth quarter, was defined by a strong and widespread correction.
Between January and March 2026, the Clever 50 fell 14.54%, the Nifty Smallcap 250 fell 14.36% and the Nifty Microcap 250 fell 16.20%. It was one of the toughest quarters Indian stock markets have seen in recent times, due to escalating geopolitical tensions, fears of wider conflict and a sharp rise in crude oil prices.
In this context, Qode Growth Fund recorded -0.20% in the fourth quarter, compared to -14.36% for its benchmark index, representing an outperformance of more than 14 percentage points over a single quarter.
Over 1 year, QGF has generated a return of +7.13% compared to -5.40% for the Nifty Smallcap 250, and since inception, the fund has generated a return of +10.55% compared to +2.50% for the benchmark index.
More importantly, the fund ranked #1 among all equity PMS strategies in India for the month of March 2026, returning +1.34% in a month where the small-cap universe fell by over 10%.
The FY26 performance story is really about what didn’t happen: the decline our investors didn’t experience. This, in our opinion, is the true measure of the quality of a strategy.
Q) The fund follows a multi-factor approach combining quality, growth and value: how do you balance these factors during different market cycles?
A) We do not mechanically switch between factors based on market conditions. This would result in a timing risk that is very difficult to control consistently. Instead, our approach is to build a portfolio that sits at the intersection of quality and value at all times, with growth acting as the validation layer.
What this means in practice: We look for companies with strong earnings growth trajectories, healthy return on equity, and reasonable balance sheets, but we only buy them when the market values them at less than their growth rate.
Our current portfolio has a PEG of 0.64x, with earnings growth of 31.37% versus a forward PE of 20.09x. Compare that to large caps, which trade at a forward PE of around 29.71x with year-over-year earnings growth of just 11.12%, a PEG of 2.67x. Investors today pay four times more per unit of earnings growth in large caps than in our portfolio.
This quarter validated the approach. Our proprietary factor analysis showed that Value was the only major factor that held up during the correction, down just 3.84% compared to losses of 11-16% for the Alpha, High Beta, Momentum and Low Volatility factors.
Because our portfolio is built at the intersection of quality and value, it naturally provides a floor that purely momentum or growth-at-all-costs strategies cannot.
The key discipline is to avoid the temptation to chase the momentum when it is running. This is when valuations stretch, and this is precisely when the risk of sharp declines is highest.
Q) The maximum drawdown of the fund is significantly lower than that of the benchmark index. What risk management frameworks helped achieve this?
A) There are two distinct levels in our risk management, and both contributed significantly this quarter.
The first is portfolio construction. We aim to own companies with strong earnings fundamentals, low debt and reasonable valuations.
This means that our stock portfolio is naturally more resilient to sell-offs because we are not exposed to high-multiplication, high-momentum stocks that tend to see the biggest devaluations during periods of risk aversion.
Our portfolio companies recorded PAT growth of 17.31% YoY in Q3FY26, well ahead of their large-cap, mid-cap and small-cap peers, reflecting genuine business quality rather than price dynamics.
The second layer, and the one that constitutes the most structural differentiator, is our overlay of derivatives. This is not a tactical hedge we put in place when we feel nervous. This is a systematic, rules-based hedging mechanism that is permanently present across the entire portfolio.
In the fourth quarter, the options overlay contributed +11.08% YoY and +17.92% YoY, directly offsetting the decline in stocks during the strongest phase of the sell-off.
The combination of quality-focused stock selection and systematic derivatives hedging produced the asymmetric result we saw this quarter. Our stock portfolio absorbed some of the broader market decline, but hedging more than made up for it.
The result was a portfolio that outperformed its benchmark by more than 14 percentage points in the fourth quarter, while limiting the maximum decline to a fraction of what the index experienced.
Q) With only 30 stocks, how do you balance concentration risk versus alpha generation?
A) Thirty farms is a deliberate choice and not a constraint. Diversification beyond a certain point becomes a demerit. You end up owning the index at active fees, with the illusion of risk management but none of the benefits.
In our view, meaningful alpha comes from high-conviction positions in companies you deeply understand, not from a dispersed distribution of capital among a hundred names.
With 30 titles, each position must deserve its place. Each is selected via our multi-factor quantitative model, which examines earnings quality, valuation attractiveness and growth sustainability, then stress-tested against portfolio-level concentration and correlation risk.
Concentration also has an important behavioral dimension. When you own fewer companies, you monitor them more rigorously. Our quantitative process continually tracks the earnings and valuation profile of each holding, and the portfolio is rebalanced annually to ensure we do not hold companies whose investment thesis has weakened.
In practice, 30 well-chosen small-cap companies across various industries and end markets provide true diversification of business risk, which is what ultimately matters, while maintaining the concentration needed to generate meaningful alpha.
Q) What is the reason why you maintain an equity exposure of around 89% and a cash exposure of 11%? Are you positioned defensively?
A) The cash component requires a bit of unpacking, as it is not cash in the traditional defensive sense. A significant portion of this amount represents profits made on our options positions that have not yet been redeployed, alongside the standard buffer we maintain for ongoing options activity. This is working capital for the derivative overlay, not idle capital waiting for the market to continue to fall.
That said, we also don’t artificially seek to fully invest. At current valuations, we believe the equity holdings we hold are attractively valued, and we see no reason to dilute the portfolio with lower conviction positions simply to achieve a notional target of 100% in equities.
The most important positioning signal lies in our valuation indicators. Our Valuation Spread Index currently sits at 37, suggesting that shares are trading at a significant discount to historical norms.
Our relative valuation gradient has increased to 92, one of the highest numbers we have observed, indicating that small- and micro-cap companies are significantly undervalued relative to large-cap companies.
These signals tell us that the risk-reward of our current holdings is truly attractive and that the environment encourages us to remain invested with patience rather than raising cash defensively.
Q) Small caps have been volatile: how are you positioning the portfolio in the current market environment?
A) Small-cap volatility is nothing new and it’s not something we try to avoid. It’s something we try to use. The fourth-quarter correction was broad and driven by sentiment, not fundamentals.
Our portfolio companies reported PAT growth of 17.31% YoY in Q3FY26, but prices fell in line with the broader small-cap universe. This divergence between generated profits and market prices is precisely the environment in which patient and disciplined investors build positions at attractive prices.
Our current positioning reflects this conviction. We are not moving to large caps or increasing our liquidity in anticipation of increased volatility. The data does not support this decision. A PEG of 0.64x on a portfolio growing earnings at over 31% is not a position you want to abandon because the headlines are tough.
What we have done is use the rebalancing process to improve quality within the small cap universe. During the fourth quarter, we reduced a position heavily exposed to export revenues in the United States, where tariff uncertainties made near-term earnings visibility difficult, and we redeployed this capital into a cybersecurity company focused on the national market, offering strong order visibility and good margin quality. This is an environment that rewards selectivity within the small-cap universe, not a wholesale withdrawal from it.
Our proprietary indicators also signal improving conditions. The Trend Navigator has begun to recover from its deeply compressed lows, and the relative valuation gradient at 92 marks one of the most compelling relative entry points for small companies that we have seen in several years.
Q) What investment horizon should investors reasonably have to benefit from this strategy?
A) We are upfront about this. QGF is not designed for investors with a time horizon of one to two years. This is a small-cap strategy, and investing in small-cap companies almost by definition requires patience to navigate periods of valuation compression that have no relationship to the underlying performance of the company.
The current quarter is a good illustration of this. Our portfolio companies are seeing earnings growth of over 31% year-over-year. They are not in financial difficulty.
Their competitive positions have not deteriorated. Yet prices fell sharply because macroeconomic fears triggered indiscriminate selling across the segment. An investor with a two-year horizon might think about it and feel uneasy. An investor with a five-year horizon looks at this and recognizes it for what it is: an opportunity.
We recommend a minimum horizon of three to five years, ideally longer. The small and mid-cap valuation anomaly, where you pay 0.64x PEG for 31% earnings growth, does not persist indefinitely, but the market correction process can be slow and non-linear.
The investors who benefit the most from this strategy are those who stay invested throughout the cycle, allowing the mix from high-quality earnings growth to assert itself as valuations normalize.
Q) What would be your key message to investors considering investing in QGF in FY27, amid pessimistic and doom and gloom globally?
A) The best time to invest in quality small-cap companies is precisely when it feels uncomfortable, and right now, it feels uncomfortable.
Let’s look at the data objectively. Our portfolio trades at a forward PE of 20.09x versus trailing earnings growth of 31.37%, a PEG of 0.64x. Large caps trade at a PEG of 2.67x.
Investors currently pay four times more per unit of earnings growth for safe large caps than for quality small caps. This is a striking divergence, and one that history suggests will not persist over a three to five year horizon.
Our relative valuation gradient, which measures the relative attractiveness of small-cap versus large-cap companies, is 92, one of the highest numbers we have ever observed. Historically, reading developments at this level have preceded some of the most attractive performance periods for patient investors in small companies.
The companies in our portfolio are growing. Valuations are attractive. The derivative overlay has been shown, under real market conditions, to significantly limit drawdowns. And our Trend Navigator signals that the period of peak uncertainty may give way to a period in which clearer trends begin to emerge.
Gloom and doom dominate the headlines. They also make compelling entry points. For investors willing to ignore the short-term noise and think in terms of a three- to five-year business cycle, FY27 may well be considered one of the best entry points into quality small-cap stocks in recent years.
Our message is simple: stay patient, stay disciplined and invest with a manager who has the tools, both on the equity side and systematic risk management, to navigate what comes next.
(Disclaimer: The recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)
