Why small caps will continue to sizzle

On Monday, when both the benchmarks lost a little under three percent each, the BSE Midcap index was down 3.6 percent while the BSE SmallCap index fell 4.21 percent.

Mid-cap and small-cap stocks may well have lost heavy ground on Monday – they lost much more than the large-caps – but if market experts are to be believed then there are enough drivers in play for the segment that would lead to the side counters continuing to outpace their larger counterparts in the near future.

The biggest driver, they say, is the strong SIP flow in schemes focused on mid-caps and small-caps that will keep the rally going even amidst valuation concerns.

Mid-cap and small-cap stocks may well have lost heavy ground on Monday – they lost much more than the large-caps – but if market experts are to be believed then there are enough drivers in play for the segment that would lead to the side counters continuing to outpace their larger counterparts in the near future.

The biggest driver, they say, is the strong SIP flow in schemes focused on mid-caps and small-caps that will keep the rally going even amidst valuation concerns.

On Monday, when both the benchmarks lost a little under three percent each, the BSE Midcap index was down 3.6 percent while the BSE SmallCap index fell 4.21 percent. On Tuesday as well, while the markets closed marginally in the red, the broader indices lost more than the Sensex and Nifty.

“The sticky money coming through SIPs supports these (mid-cap and small-cap) segments,” said Shwetha Rajani, Head of Mutual Funds at Anand Rathi Wealth.

Net SIP inflows in June were pegged at a record high of Rs 21,262 crore. Of this, around 40 percent is into large caps and 30 percent each into mid and small caps. That will continue to come through, Rajani suggests.

Morningstar's Director of Research, Kaustubh Belapurkar concurred. He said that SIPs are a disciplined way of investing while avoiding the emotional aspect of market timing. “SIPs are especially useful in volatile assets like small and mid-caps, reducing timing risk,” Belapurkar added.

Interestingly, the optimism comes at a time when many in the market have been talking about valuation concerns in the mid-cap and small-cap segments.

Utsav Mehta, Fund Manager – Equity, PGIM India MF, highlighted the fact that small- and mid-cap stocks have had a stellar run in the last two years even though there were signs of valuation excesses in specific pockets, primarily led by strong corporate earnings and domestic inflows.

“These excesses will be tested time and again by major events domestically and globally leading to volatility and moderation of valuation excesses. However, there are good investment opportunities in the ‘quality’ bucket of companies where valuations are reasonable and earnings visibility intact despite global events. We are focused on those that should outperform over the medium to long term and protect downside,” Mehta said.

Data from the Association of Mutual Funds in India (AMFI), shows that mid-cap and small-cap schemes continue to see strong inflows. In June, large-cap funds saw inflows of Rs 970.5 crore, small-cap funds attracted net flows totalling Rs 2,263 crore, and mid-cap funds saw inflows of Rs 2,528 crore.

In terms of returns, small-cap funds, on an average, have given returns of 48 percent, 35 percent, 24 percent, 33 percent, and 21 percent, across one-year, two-year, three-year, five-year, and 10-year time periods, per Moneycontrol data.

Incidentally, experts believe that going ahead investors should maintain more realistic expectations when it comes to returns.

“The significant run-up in markets, especially in small and mid-caps, has led to outsized returns compared to the broader market. However, expecting 18-20 percent returns going forward is unrealistic,” Belapurkar said.

For example, small and mid-caps saw significant gains in 2017, but thereafter, 2018 and 2019 were bad years for small caps. Small and mid-caps are more volatile than large caps, and investors need to understand this, Belapurkar added.

So what should investors do?

“There are steady inflows into mid and small-cap spaces every month. Considering all this, the rally of mid and small caps versus large caps can continue this year at a lower base than last year. Ideally, investors should have around 55 percent in large caps and 45 percent in mid and small caps and keep watching these signals," Rajani advised.

In a similar context, Belapurkar said that going ahead, investors should avoid excesses, have realistic expectations, be patient, maintain a long enough time horizon, and ensure proper asset allocation.

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