Transcript

Akshara Menon: Hi everyone, I’m Akshara and welcoming you to yet another fund manager interview series with PMS Bazaar. Over the past few months, markets have been quite volatile with frequent ups and downs, creating uncertainty. Identifying emerging growth opportunities is more important than ever, and one segment gaining attention is the Small and Medium Enterprise (SME) ecosystem. To help us understand this, we are joined today by Mr. Rishi Agarwal, co-founder and fund manager of Aarth Growth Fund. Welcome to the show, sir.

Rishi Agarwal: Thank you, Akshara.

Akshara Menon: Rishi, let me start with a common question. You’ve worked with big CXOs, managed funds for family offices, treasuries, and sovereign funds. Now you’ve started your own MSME fund. Why did you choose this space, and where do you see the institutional money coming from?

Rishi Agarwal: I honestly believe it chose me more than I chose it. I belong to a business family that is all about MSMEs. We are a typical Indian joint family structure where the third generation was given a certain standard of living starting from very humble backgrounds. That personal history, backed by 10 years at PWC interacting with Global Fortune 500 and Nifty 50 companies, brought the necessary risk management experience to the table.

As a country, we are in a high-growth phase and we like to take more risk for more returns. MSMEs are the answer. We’ve watched this space for 14 years, since 2012. We started as a "me-too" to China. If you look at China, MSMEs represent at least 1/4th of their entire market cap, and they started back in 2004. India is currently just 5% of the market cap in MSMEs. We have a 20% gap to capture, plus our country's overall size is growing. The space was ripe for institutions. On my own table, my co-fund manager has been investing for 12 years, and our sponsors are merchant bankers from the NSE and BSE who understand the promoter ecosystem. It was the right time and the right "apple" in my hand.

Akshara Menon: You’ve mentioned before that your approach is like private equity (PE) but in a public market space. How do you see the difference in terms of underwriting and value?

Rishi Agarwal: We practice "PE-style investment in public markets" to our heart. Historically, this style has given a 5% alpha over public markets globally. The challenge with pure public markets is that people only look at the next two or three quarters. In a PE-style investment, you have a J-curve where profits might actually go down before they boost up due to operating leverage, capex stories, or achieving product-market fit.

Today’s patient capital in India wants 15-18% returns. That comes with visibility. But the "explode" stage comes when you take the risk that 6 out of 10 companies will do well. Out of the remaining four, two might wipe off completely because they can't convert the business model or their earnings aren't enough. In public markets, the cons are low liquidity and the fact that institutions take years to build confidence. They do stage investments and factory visits. You need the gumption to see a 40% drawdown on a script while maintaining a blend of alpha and liquidity.

Akshara Menon: You mention 15-18% returns, but markets have done poorly lately due to geopolitical tensions. Even though India isn't directly correlated to the wars, we were affected. How do you see current valuations, especially in microcaps?

Rishi Agarwal: I haven't analyzed all 3,000 microcaps, but we do a monthly analysis on our portfolio. My portfolio's Trailing Twelve Months (TTM) P/E is between 18 to 20. My forward P/E for FY26 is 16. I am expecting a 20% upside just from results being announced in May. Looking way ahead to FY28, I expect the portfolio P/E to come down to 12 based on capex, operating leverage, or product-market fit.

Since September 2024, we've seen a de-rating across large, mid, and small caps. Small caps went down 27% during the trade war. It's recovered 7% but is still 20% down from the top. Our portfolio is also down 20% from the top. However, we ensure capital preservation. Our downside capture ratio is 0.5—meaning when the market goes down 1 rupee, we go down by 0.5 rupees. We don't invest in any idea where the downside risk is greater than the upside.

Akshara Menon: You've been an anchor investor in 64 IPOs since December 2024. Among those, 36 are "in the red." Everyone seems to be bleeding. How do you handle investor anxiety and redemptions?

Rishi Agarwal: It’s easier said than done. For us, it’s even tougher because we have put in 10% of the entire AUM ourselves. We are the biggest investors in the fund. We get the same sleepless nights—probably 10 times more than other investors—because we have skin in the game.

Philosophy-wise, we follow the math: right allocation and no "bullet investments." You can never capture both the peak and the bottom. People say you can't time the market, yet every investor asks "is it a good time to invest?" No one ever asks "is it a good time to exit?" That’s the fear. Portfolio allocation should happen with a financial advisor based on age and goals, not by chasing historical returns.

To be fair, while 36 are in red, 28 are in green. Seven of them have given 100% returns. That is the power of microcaps. Even in a market where indices have done 20% negative, we are still positive on an annualized basis. Our capital is not eroded. 40% of our bets are in the green, and 30% of the portfolio has doubled. This compensates for the losers.

Akshara Menon: What about the sectors that aren't performing right now?

Rishi Agarwal: Many sectors are facing headwinds. When we started, events didn't turn out as expected. IT is struggling because of AI. Renewables are facing headwinds because government capex went down. Also, globally, non-renewables are doing better because the "big boy in North America" feels global warming is a sham. These events aren't in our hands, so we diversify.

Regarding our 64 anchor investments, 80% of them I have doubled down on "on-screen" at higher or lower prices depending on my 3-year conviction. On a 500 cr portfolio, roughly 30% is invested at anchor; the rest is on-screen QIB.

Akshara Menon: Most value is created in the pre-IPO space. Why should an investor stay after listing?

Rishi Agarwal: In behavioral finance, we have "recency bias" from newspapers. You read about a startup raising money, but that’s only 2% of reality. The J-curve fails for 90% of businesses.

Many of my ultra-HNI investors who tried pre-IPO on their own realized they didn't have an institutional-scale team. Often, they invested based on "dinner conversation" confidence—like what you see on Shark Tank. People see a 10-minute pitch, but it’s actually a three-hour session, and money often doesn't arrive until 6 months after the term sheet.

For anyone looking at pre-IPO now—since the primary screen market is bad—you must ask: Is this a primary or secondary raise? If primary, is the money for capex or working capital? If secondary, who is selling and why? You must understand unit economics and, if you're putting in over 1 CR, you must do a factory visit and meet the promoters.

Akshara Menon: You have a huge promoter network. Isn't that a double-edged sword where you might get swayed because you know them?

Rishi Agarwal: That’s why we have a 15-person analyst team. They have strict instructions to have no bias. They produce "black and white" reports every quarter for companies over 500 cr and every six months for those below. We look at the thesis vs. anti-thesis, red flags, and what was committed 6 months ago.

Because five of us have networks across merchant bankers and promoters, if one of us is a "good friend" with a promoter and can't ask tough questions, another partner takes over. Also, our network allows "cross-pollination." If one company needs a vendor and another in our portfolio fits, we connect them and step out. We facilitate the ecosystem.

Akshara Menon: How do you see the MSME re-rating happening through FTAs and policy support?

Rishi Agarwal: MSMEs are the key to manufacturing. 70% of MSME money in China went to manufacturing, creating a supply chain that allows big players to service global clients. FTAs allow global MNCs to partner with Indian manufacturing. It gives them quality and supply chain diversification away from regions at risk due to political or economical disruption. Apple making 1/4th of the world’s production in India is proof. It gives Indians the push to seek equity capital.

Akshara Menon: The government has infused 10,000 crores into this space. How is that resonating with growth?

Rishi Agarwal: The government is doing a wonderful job, partly for their own good. Government supply chains are at risk because of dependency on global imports in defense and infra. They realized they have to put skin in the game.

Previously, the sentiment was "we will give you credit without collateral." Now, it's "we will give you equity investment." Moving from grants or credit to equity makes the government a partner in the risk-taking. That sentiment really moves the needle.

Akshara Menon: When you take a major stake, do you enter the decision-making process?

Rishi Agarwal: We completely stay away from business and management decisions. Most of our companies have 50% plus promoter equity; they live and breathe the business. They know it better than us. We act as a "mirror" and provide support during depressions. We facilitate fundraising so the promoter doesn't have to go back to the drawing board with a merchant banker.

Akshara Menon: You are sector agnostic, yet 30-40% of your portfolio is in Capital Goods, Infra, and EPC. What is the outlook there?

Rishi Agarwal: That’s an outcome of valuation. Capital goods support infra and help with indigenization so we stop importing dyes and machinery. As for Infra and EPC—I saw Chennai airport grow 5x in seven years. We need water, air, and sanitation to reach the 2047 developed market goal. L&T can't do it alone; MSMEs must find local solutions.

While India typically allocates 2-4% of GDP to infra, we are going at 8%. With dedicated institutions like IRFC for railways or REC for power, there is a multiplier effect. Also, 25% of all government spending is dedicated toward MSME procurement. That is a massive, dedicated demand.

Akshara Menon: Finally, 300 SMEs have migrated to the Main Board. What factors are driving this?

Rishi Agarwal: It’s a bit technical. NSE and BSE have their own listing and migration norms. A company must meet criteria and pay a fee to migrate. Our analysis of these companies shows a 5-year average sales growth of 20% and a PAT (Profit After Tax) growth of 25%. This 25% CAGR is what allows the re-rating and the move to the Main Board where there is more liquidity.

You can list directly on the Main Board, but in the last few years, we’ve seen 300 SME IPOs. This has actually scared the regulator because they are afraid of outliers. If three companies out of 300 go bust, it ruins the entire sentiment.

Akshara Menon: We were talking about the migration of SMEs to the Main Board. You mentioned the regulator is a bit cautious. How is that affecting the ecosystem?

Rishi Agarwal: Exactly. Because of the fear that just three bad companies out of 300 could ruin the entire market sentiment, the exchanges have made migration very difficult. Now, we are seeing a shift. Companies with a market cap of 600 cr or even 2,000 cr are choosing to list directly on the Main Board instead of the SME exchange. I speak to about 50 merchant bankers regularly, and they are now guiding companies to do a small pre-IPO round of 30–40 crores first, then wait two years to hit the Main Board. It’s more capital-efficient. SMEs often have lower P/Es not because they are bad companies, but because institutional investors need high liquidity to handle redemptions. They’d rather take a 40% hit on a liquid stock they can sell instantly than wait out a patient investment.

Akshara Menon: For a new investor looking at the current market—where Nifty is down 3,000 points and portfolios are red—what three tips would you give them before they step into the SME space?

Rishi Agarwal: 1. Manage Expectations: Don’t expect 40–50% returns. Equity is about relative returns—how much more you get from this segment compared to others. In microcaps, you should aim for a 10% alpha over the small-cap or mid-cap indices. 2. Avoid "Bullet" Investments: Invest across a time period. Right now is a great time because we are 20–30% off the peak, but don't put it all in at once. 3. Watch for Disruption: We are in a "Decade of Disruption."

Akshara Menon: What kind of disruptions should they look for?

Rishi Agarwal: It’s everywhere. Tech disruption is obvious, but there is Demographic disruption—changes in age, population mix, and gender in the workspace. There is Power disruption, moving from a bipolar to a multipolar world. Even the current wars are often about race and resources. Business models built on old assumptions—like being 90% export-oriented—are being challenged. You need a balance of localization and globalization now. A three-month supply chain disruption can wipe out a globalization-only business.

Akshara Menon: As a fund grows, alpha often saturates. What is the "saturation point" for an MSME fund like yours?

Rishi Agarwal: We did the math and initially set our fund at 500 cr. We believe the saturation point is around 5,000 cr AUM because the market size we target is roughly 5x that. However, with 250 to 300 new companies coming to market every year, that capacity is growing. Five years ago, an average SME IPO was 28 cr; today it's 35–50 cr, and soon we'll see 80 cr+ averages. We’ve seen this boom-and-bust cycle in China, and they now do 300+ IPOs annually even in a mature state. India isn't even at the mature stage yet, so we haven't captured the full pie.

Akshara Menon: So the ecosystem still needs to evolve?

Rishi Agarwal: Yes. We have to accept that you can't mitigate every risk. If the government is putting in equity, they aren't asking for a CAGR five years from now—they are showing confidence. Investors need that same stomach for uncertainty. Since we got our approval in September 2024, we’ve seen a complete drawdown. Yet, we haven't lost net capital for any investor who joined in our first six months. Even "safe havens" are volatile—if you bought gold at Diwali, you'd be at a loss today. Gold has only given 9.8% returns over 30 years, while the small-cap index gave 19%. By avoiding that 10% alpha because of fear, you lose out on a massive compounding effect.

Akshara Menon: Let’s get personal. If a person has 10 lakhs, 50 lakhs, or 1 crore right now, where should they put it?

Rishi Agarwal: * 10 Lakhs: If that's all you have, invest it in yourself. Upskill until you can earn 1 crore. Skills are the most secure asset.

• 50 Lakhs: Put one year's worth into an emergency fund and use the rest to experiment with an entrepreneurial journey.
• 1 Crore: Look for a double-digit growth industry with a 1,000 cr market size. Use that 1 cr to capture 10% of a niche, set up a factory, find partners, and spend five years building.

Akshara Menon: You clearly have an entrepreneurial bloodline! If you weren't a fund manager, what would you be doing?

Rishi Agarwal: My family is into products—manufacturing and supply chain. But I’m a service person. I enjoy finding "white in gray areas." I would probably be in research—either for public good in education or selling research to create wealth.

Akshara Menon: You're a third-generation businessman. Why did you "dish" the family expectation to join the core business?

Rishi Agarwal: By the time I finished my CA and CFA, I realized the first-generation business had saturated; it didn't have 20% CAGR growth anymore. I asked myself: "Does my addition create alpha in this business?" The answer was no. Plus, my passion was elsewhere. My parents are in their late 50s and can still manage the business. In our joint family, the third generation is very diverse now—my brothers are in mining, tech, and automotive supply chains. Our dinner conversations are much wider now!

Akshara Menon: It seems your "research mind" even applies to your family dynamics. Any final words?

Rishi Agarwal: Primary research and experiential learning can never be substituted by theory. I believe in reading and upskilling constantly. Every three years, I do a structured course to learn something from zero so I don't get biased by my daily work. Never stop reading, and never stop learning.

Akshara Menon: Thank you, Rishi. We’ve learned so much—from MSMEs and geopolitics to the man behind the fund manager mask. It’s been a pleasure.

Rishi Agarwal: Thank you, Akshara. Much appreciated.