Both mid and small-cap indices have outdone Sensex returns. How long will this rally sustain?
What are the portfolios and stocks that come to one’s mind when an investor hears of marquee Indian investors like Rakesh Jhunjhunwala, Vijay Kedia, Dolly Khanna, Porinju Veliyath and the likes.
The one thing they have in common is a large population of mid and small cap stocks in their portfolios.
For one, the mid and small cap space has a lot of potential large caps of tomorrow, that attracts attention of Marquee investors and mutual fund schemes based on this theme.
Recent period returns
Large-caps led the rally initially, but lately mid and small-caps have grabbed investor attention. The BSE Mid Cap Fund Index rose almost 30 percent while BSE Small Cap Index posted nearly 39 percent gains since March 26 outperforming the 23 percent gains by BSE Sensex.
Even in the one month period, both mid and small cap indices have outdone Sensex returns. Mid-cap index went up by 18 percent, while BSE Small Cap rose 20 percent in the last month. In comparison, BSE Sensex gained 15 percent.
In line with this, mid-cap and small-cap funds too delivered robust returns. In one-month period, mid-cap funds category delivered 13.26 percent average returns, and small cap funds category gave 16.31 percent average returns. Large cap funds fetched 13.53 percent average returns, according to Value Research.
With the economic downturn hurting smaller companies, this rally seems speculative and could trap retail investors.
The economy is likely to be severely affected by the COVID-19 pandemic as well as from the ensuing lockdown, and there is a likelihood of defaults in the Micro, Small and Medium Enterprises (MSME) space.
Business revenues have been hit, Avnish Jain, fixed-income head, Canara Robeco Mutual Fund, told Moneycontrol.
There could be ‘continued funding squeeze’ on mid- and small-size companies, which could lead to defaults, he says. Jain is concerned that in the manufacturing space, there could be more stress and higher defaults.
The key test of mid and small caps is in equity crisis situation when there is a flight out of equity risks to other places. In a panic sell mode markets, mid and small caps see heavier selling than large cap stocks, that places them at serious disadvantage.
Witnessing higher sellers than buyers in panicking market conditions, small cap stocks and lower mid cap stocks turn illiquid. This illiquidity sees firesale prices in small caps like one noticed during February - March 2020 decline.
Known investor Vijay Kedia is murmured to have crooned 'Dil ke Armaan Aansoun mein Beh gaye' (All hopes are shattered) at a gathering when stock Repro Graphics turned illiquid.
The company is solo manufacturer of a print material but faces other bottlenecks to its growth that has taken away shine in it's potential.
Seasoned small-cap investor Porinju Veliyath was heard accepting his below par performing small-caps in 2019, post which he is known to have revised his investment strategy.
Mid and small-caps are markets' outperformers but with such riders.
Retail interest in mid, small-caps
According to mutual fund experts, for the non-active retail investors, it is best to pick up consistent performers among mid, small-cap MF schemes rather than invest directly, because of inherent high volatility risks.For the seasoned retail investor, direct exposure to mid and small-caps should be a portion of portfolio, with bigger chunk in safety of large and liquid stocks.