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Mumbai: After a marathon run that lasted from 2014 till late 2017, mid- and small-cap stocks seem to have run out of breath.

Thanks to expensive valuations and quality concerns, these stocks have underperformed BSE’s benchmark 30-share Sensex in the year so far, as investors locked in gains before the expected turbulence of next year’s general election.

The BSE mid-cap index and BSE small-cap index are down 12.84% and 15.66% respectively in the year so far, while the Sensex itself is up 2.49%.

The uninspiring show is in sharp contrast to 2017, when the mid-cap and small-cap indices logged 48.13% and 59.64% gains respectively, while the Sensex clocked a more mellow 27.91% gain. These stocks have performed especially badly in May as well the three sessions so far in June.

“Some of this is giving back the stellar returns of last year," said Ridham Desai, India equity strategist at Morgan Stanley.

Then what happens is once you get a breakdown in prices, you get a viscous turn in liquidity, and so the liquidity, which I would define as the force on the bids has abated," said Desai.

“I think it will take a little while (to trough out) and we will not get a V-shaped recovery," he added.

UBS’s India securities arm also voiced its concerns on the pack, noting investor interest may have peaked for now.

“The economic growth cycle is less strong now than in historical tightening periods, and this is reflected in earnings cuts. The rise in interest rates is not counter-cyclical," UBS Securities India Pvt. Ltd said in a note on Monday.

“SMIDS (small and mid caps) have started underperforming with rising interest rates recently. We expect this to remain an overhang; our UBS economist forecasts a 50bp (basis points) repo rate hike in FY19," they added.

One basis point is a hundredth of a percentage point.

“The best of local retail flows supporting SMID outperformance may be behind us, at least cyclically. Local flows follow returns, not the other way around," they said, adding UBS is underweight small- and mid-cap stocks as an asset class in its portfolio positioning recommendation.

From the record highs posted by BSE mid-cap index and small-cap index respectively on 9 January and 15 January, around three and 85 stocks in the respective indices have eroded at least half of their value.

Apart from rich valuations and profit-booking, a host of other factors have been worrying the market, and specifically the mid- and small-cap segment.

“The noise around auditors pulling out had bothered the mid- and small-cap pack. On top of this, Sebi coming up with an additional surveillance mechanism added fuel to fire," said Rahul Shah, vice-president of equity advisory group at Motilal Oswal Securities Ltd.

There were stock-specific issues as well. Vakrangee Ltd, the top mid-cap loser in the year so far, has lost 91.89% since the start of the year. Similarly, Gitanjali Gems Ltd, is the top loser among BSE small-cap stocks, with a value erosion of 89.59%. While the Vakrangee stock collapsed following reports that it was being probed for alleged manipulation in share price and volume, the alleged involvement of Gitanjali owner Mehul Choksi in a $2-billion fraud at state-owned Punjab National Bank took toll on its stock.

“Next year is election year, and these developments prompted investors to book profits too," Shah of Motilal Oswal added.

“The confidence in the pack dwindled, and even good stocks such as Avanti Feeds and HEG corrected. All this had a cascading impact -- people withdrew more funds out of the small and mid-cap pack, as panic set in," said Shah.

A few were of the opinion that it may be a good time to go stock-picking in the pack, as wealth creation was always a better idea with the mid- and small-cap pack.

“From a long-term perspective, buying into (mid- and small-cap) companies doing well, and run by reasonably competent people, can be a good idea for wealth creation," Soumendra Nath Lahiri, chief investment officer, L&T Investment Management Ltd,

“Wealth creation is always optimum with mid and small cap, rather than large cap. They are usually the undiscovered, and under-owned stocks," said Lahiri.

“With mid- and small-cap, one needs to do their homework well, and stock selection is key," added Lahiri.

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