Small caps rally in India boosts emerging markets index

Indian companies have a weight of 27.82% in the MSCI Emerging Markets Small Cap index, followed by Taiwanese companies with 22.24% and South Korean firms with 12.4%. Photo: Reuters
Indian companies have a weight of 27.82% in the MSCI Emerging Markets Small Cap index, followed by Taiwanese companies with 22.24% and South Korean firms with 12.4%. Photo: Reuters

Summary

  • Over the past year the MSCI Emerging Markets Small Cap index has gained 16.5%, beating the large cap index’s return of around 9%.

The ongoing rally in Indian small cap stocks has boosted the MSCI Emerging Markets Small Cap index. Over the past year it has gained 16.5%, beating the large cap index’s return of around 9%.

The MSCI Emerging Markets Small Cap index includes small cap companies from 24 emerging markets. Indian companies have a weight of 27.82% in the index, followed by Taiwanese companies with 22.24% and South Korean firms with 12.4%.

IT company Coforge Ltd, commercial realty firm Embassy Office Park REIT, and private sector lender Federal Bank Ltd are the Indian stocks among the index’s top 10 constituents, according to an MSCI factsheet dated 31 January.

The optimism around artificial intelligence and electric vehicles could be boosting investor sentiment in the tech-focused markets of Taiwan and South Korea. Back home, a huge influx of domestic and foreign institutional funds has caused the stocks of small cap stocks to jump as investors chase mouthwatering returns. Over the past year, the Nifty SmallCap 100 index has risen nearly 73% while the Nifty 50 has increased by relatively modest 24%.

“In our view, the confidence of retail investors stems from strong returns over the past one to three years (during which time large caps have lagged), which has led them to believe that they can only make money in the Indian equities market and that they will earn very high returns, especially from mid cap and small cap firms," read a Kotak Institutional Equities report dated 15 February.

On select earnings parameters, small companies continue to fare better than their larger peers. An analysis of BSE 500 companies by Nuvama Research showed that the top line growth of small and midcaps (SMIDs) slowed over the past year, but was higher than that of large caps on aggregate basis in the third quarter of FY24.

"In the December quarter, SMID margins were at much higher levels (a decadal high) than their own history versus large caps. However, this trend is likely to be at the fag end as tailwinds from lower input prices are now fading," said Prateek Parekh, vice president, institutional equities, Nuvama Wealth Management.

The valuations are also expensive. The one-year forward price-to-earnings multiple of the Nifty Small Cap 100 index is 18.37 times, almost in-line with the Nifty’s 18.18 times, according to Bloomberg data. This leaves no room for a margin of safety. Also, any surprise in upcoming general elections could hamper the stock market’s momentum. This could hurt small cap stocks more than blue chips as they are perceived to be riskier.

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