Do not disproportionately raise exposure to small, mid-cap stocks

Mid-cap equity mutual fund schemes garnered R1,749 crore in June and R1,623 crore in July.

MUMBAI: With the stock market rallying to new highs in recent months, mutual funds have seen record inflows of investors’ money. Within the mutual fund industry, small-cap mutual fund schemes have emerged as star performers attracting record funds from investors in the past few months.

Net inflows into small-cap equity mutual funds touched a record high of R5,472 crore in June, according to the Association of Mutual Funds in India (AMFI) data. In July, the net inflows in small-cap funds reached R4,171 crore. Investors have poured in R22,040 crore in small-cap funds since January this year.

Showing a similar trend, mid-cap mutual schemes have caught investors’ attention. Mid-cap equity mutual fund schemes garnered R1,749 crore in June and R1,623 crore in July. While inflows in small and midcap funds have swelled, the investors turned a blind eye to large-cap funds and pulled out investment from these funds. The large cap equity mutual fund schemes witnessed R2,049 crore outflow in June and R1,880 crore in July.

Surge in small and mid-cap 
Investors’ money is chasing high growth and profitability and small and mid-cap companies have lived up to their expectations. Stock prices of small-cap companies have risen sharply in the past few months which is visible in the outperformance of small-cap index. While the BSE Sensex risen nearly 7% since January this year, the BSE SmallCap Index has surged 21% in the same duration. In the past four months (April-July), the BSE SmallCap Index has soared 28% while Sensex has risen 12.5%.

“Over the last three years, Nifty Midcap 150 index, and Nifty Small Cap index have outperformed Nifty 100 Index, by delivering more than 30% compound annual growth rate (CAGR) returns, compared to around 20% CAGR by Nifty 100. Stupendous performance by small and midcap indices during last three years have pulled up their long-term return as well, and investors are naturally attracted by past returns provided by any asset class. This seems to be the reason behind increased inflow in these funds,”

Dikshit Mittal, Fund Manager and Senior Equity Research Analyst, LIC Mutual Fund Asset Management told this newspaper. India is a developing country, and many upcoming sectors like QSR (Quick Service Restaurant), logistics, building materials, and many sub segments in manufacturing are still in infancy stage and are available only in mid and small-cap space. “Mid-cap and small-cap stocks have outperformed the large-cap companies over the last few quarters, leading to higher persistent inflows into mid and small-cap funds. There has been a tailwind for companies in form of benefits accruing from formalisation of the economy and consumer premiumisation,” Sandeep Bagla, CEO, Trust Mutual Funds said.

What should retail investors do?
The going has been good so far for the small and mid-cap funds but investors should not get swayed by their past performance. Small-cap schemes offer higher returns compared to large-caps but they carry more volatility. Experts recommend investing for the long term in small and mid-cap funds. “The inflows are as a result of past performance of funds. The inflows could moderate going ahead if markets are correct. Investors should note that Small and Mid Cap Funds carry relatively higher risk and they should have at least five years or more horizon while investing in this category,” Ajit Menon, CEO, PGIM India Mutual Fund said. “We recommend investors to take the guidance of a trusted advisor who can help investors understand their risk profile and invest as per their life goals,” Menon added.

The exposure of retail investors to mid-cap and small-cap funds should be in proportion to their overall equity allocation. Better-than-expected performance in the past few months should not lure investors to increase investment disproportionally to one particular fund category.

“Markets can overshoot the fair value estimates both in bullish as well as bearish conditions, on the higher as well as the lower side. There is strong momentum in small and mid-cap funds which may not sustain due to tight liquidity conditions and moderation in valuations. Investors should limit their exposure to mid-cap and small-cap funds at a prudent proportion to their overall equity allocation,” said Bagla.

According to experts, diversification should be the key to investment strategy and investors should avoid overexposure to a specific asset class.

Will small & mid-cap funds continue to shine?
The impressive performance of small and mid-cap funds is unlikely to continue. The pace of inflows into small and mid-cap funds is expected to slow down in the coming months due to high valuation and slowdown in earnings of these companies.

Small and midcap funds will continue to attract investors as they have the potential to generate higher returns as compared to large cap funds over the long run.“It is difficult to take a call on flows in the short term as inflows are dependent on many factors including past returns, level of optimism in mind of investors and performance of alternative asset classes.

However, what we have seen in last many years is that though flows are cyclical in short term, but over the long term, trajectory is upwards as India is still a hugely underpenetrated market as far as equity investments is concerned,” said Dikshit Mittal.

Investors chase better returns

28% Rise in BSE SmallCap Index in past four months (April-July)

21% Rise in BSE SmallCap Index since January this year

12.5% Increase in BSE Sensex in past four months (April-July)

7% Rise in BSE Sensex since January this year