Small-caps get their mojo back after a prolonged lull

After a prolonged lull, smaller companies are finding favour with domestic investors to bring respite to many embattled promoters. While small-caps, comprising companies with market capitalization of ₹5,000 crore or less, are typically seen as riskier bets, compared to mid- and large-cap firms, and prone to extreme price volatility, especially in times of economic uncertainty, they made a comeback in June.

The BSE SmallCap index rallied almost 10% during the month, compared to the gains of 6.89% of the BSE Midcap index and Sensex’s 5.62% increase.

Industry watchers said the rise in the small-cap index will offer an opportunity to promoters with high percentage of pledges to potentially gain some reprieve from lenders once the loan moratorium is lifted.

“Many promoters had been told by lenders to furnish additional margins as value of the pledged shares had declined significantly since the onset of the pandemic,” said a promoter of a listed small-cap company, requesting anonymity. “But with the prices recovering, I think many will be in a better position now.”

Exchange data compiled by Capitaline showed that promoters of 182 small-cap companies had pledged their shares in the March quarter, while for mid-caps, promoters of 25 companies had pledged their shares. “As liquidity is chasing smaller stocks, this may be a good time for companies to reduce their promoters pledged shares, especially at a time when the rest of the economy is in doldrums, and very little or nil business growth,” said an analyst, also requesting anonymity.

When the markets crashed on 24 March, the BSE SmallCap index lost 57.28% from its all-time high in 2018, while the BSE Midcap and Sensex were down 47.85% and 39.35%, respectively. However, the liquidity-flushed markets saw the BSE SmallCap index recovering 37.39% from the lows of March, but is still down 41.31% from its all-time high. In contrast, the Sensex and BSE Midcap indices rose around 32% from their respective lows in March. However, the Sensex is 19.67% and BSE Midcap index is 31.46% away from record highs.

Analysts said in a rising market small-caps tend to grow faster than large-caps, while robust inflow of domestic investors’ money into equities attracted a lot of investors to smaller companies. Traditionally, due to low pricing, small-cap firms offer more frequent and better entry points, especially for retail investors.

Generally, domestic investors’ flow is tilted towards the small-cap segment, compared to foreign institutional investors, who mostly prefer large-caps. For instance, large-cap mutual funds saw an inflow of ₹1,555.59 crore in May, while the small- and mid-cap funds saw an inflow of ₹293.04 crore and ₹279.69 crore, respectively.

The rise in small-cap stocks indicate that investors are shifting to the riskier segment, as smaller companies are far more volatile than large-caps. However, in a broader market correction, small-caps tend to fall relatively more than large-caps due to higher beta, or low floating stock.