BSE Smallcap falls 2%; what should be your strategy for smallcap segment?

In recent times, the small-cap market segment has experienced a notable correction, causing it to lag behind the performance of larger-cap counterparts. This shift comes as market sentiment grows cautious, prompted by concerns over inflated valuations amid a lack of fresh triggers.

The BSE Smallcap index fell 2 per cent in intraday trade on Wednesday, March 6. The index has underperformed the benchmark Sensex since February due to rich valuations.

"Given the rich valuations, some smallcaps have fallen more than the Sensex, dragging the smallcap index. Also, developments such as smallcap mutual fund schemes restricting inflows and financial market regulator SEBI asking the mutual fund industry to be even more vigilant to protect investors’ interest, especially in small, midcap schemes are received by market participants as warnings of overheating. This has reduced the optimism of speculators in smallcap stocks," said Shrey Jain, Founder and CEO of SAS Online.

Investors appear concerned about the recent underperformance of the BSE Smallcap index. Smallcap stocks have the potential for significant growth, but they also carry significant risks and tend to fall more in times of market corrections.

Experts observe that the market is witnessing sectoral rotation which could continue for some time.

"Segment-wise, a rotation seems to be happening in the markets. Based on their relative valuations, near-term triggers, the status of global and local risk appetite and the profile of buyers, large caps and small, midcap segments keep performing from time to time," said Deepak Jasani, Head of Retail Research, HDFC Securities.

Jasani underscored that after a stellar run over the past few months, the mid and smallcap segments will need to consolidate on an overall basis, though, at a micro level, there may be outperformers among them.

"This could continue for a few more weeks and in case small and midcap segments correct sufficiently by that time, the focus could again shift back to them," said Jasani.

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What should be the strategy for smallcaps?

Smallcap segment tend to be highly volatile and risk-averse investors may choose to stay away from the segment for some time. However, experts say the segment still has select opportunities and prudent investors can pick stocks from the smallcap space.

"It is imperative that we recognise that the small-cap segment is for stock pickers," Aman Soni, Head of Operations at Prudent Equity told Mint.

"Between ₹1,000-5,000 crore in market capitalisation, there are more than 600 stocks, of which we must assemble a portfolio of around 15 to 25 stocks. Therefore, while investing in small-cap firms, one should learn to find the needle in the haystack rather than concentrating on the valuations of the larger index, which may not be an appropriate strategy. This method should continue to provide investors with lucrative returns," said Soni.

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Trivesh D, COO of Tradejini underscored that consolidation is a natural part of the smallcap journey. Historically, the periods of consolidations haven't necessarily translated into negative returns. They are often followed by strong growth phases in the next six months. Over the past decade, 85 per cent of stocks that multiplied tenfold, were smallcap stocks.

However, it's essential to approach small caps with extreme caution.

"There are two ways to invest in smallcap stocks. One way is to purchase individual smallcap stocks directly, but this strategy can be challenging due to the volatility of the segment and the difficulty in identifying potential winners. The other option is to opt for actively managed smallcap funds, each with its investment approach and varying performance outcomes," said Trivesh.

"Investors should embrace strategies that combine growth opportunities with risk mitigation to build robust and resilient portfolios for the future. It's crucial to have a long-term perspective and a diversified portfolio to mitigate the risks of investing in smallcap stocks," Trivesh said.

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Jain of SAS Online said investors must take a stock-specific approach.

"Select smallcap stocks in pharma, auto ancillaries, and discretionary consumers, can be accumulated on dips. Profit booking in smallcap IT stocks can be done now, as they may offer opportunities to enter at lower levels. Investors need to be careful with stocks in renewable energy space," said Jain.

"Short-term traders should not hesitate while booking partial profits. Existing long positions need to have a trailing stop loss. Large-cap stocks offer a better risk-reward proposition at this juncture, compared to smallcap stocks," Jain said.

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Disclaimer: The views and recommendations above are those of individual analysts, experts and broking companies, not of Mint. We advise investors to check with certified experts before making any investment decisions.