Get Instant Loan up to ₹10 Lakh!
Small-caps: Pockets of opportunity or minefields on the equity bourses? 5 experts weigh in
The small-cap segment offers lucrative investment opportunities but is prone to significant fluctuations and risks, necessitating strategic and cautious approaches for investors.
Every investor on the bourses looks for pockets where s/he can make money. And sometimes the best opportunities for making money on the bourses may cause a lot of hair-raising experiences. Experts feel that this is probably the path of investors looking to invest in the small-cap segment going forward.
Certainly, you have the ability to make a ton of money if you hit the (buy) button at the right time. Equally too, be prepared to lose money (and your hair).
“Over a long-term cycle, companies in the small-cap space have the potential to deliver a larger return on investment than large caps. But equally too they have the risk to fall more than large caps from their peaks,” says Anil Ghelani, Head – Passive Investments & Products, DSP Mutual Fund.
Small caps are stocks listed on the exchanges that have a market capitalisation of less than ₹5,000 crore. To illustrate, this year, the broader large-cap markets like the Nifty 50 Index is up by ~18% whereas the NSE Smallcap 250 Index is up by 46%.
“In the current scenario, the risk-reward equation appears more favourable for large-cap indices compared to their small-cap counterparts over next year,” says Pankaj Shrestha – Head Investment Services, Prabhudas Lilladher Wealth.
So does this mean that the investor should give small caps the miss? No. They still have the potential to deliver returns, going forward.
“We may see a movement of 12-15% in small cap space over the next 1 year as we feel the earnings are likely to grow at 14-15%. Additionally, the drop in raw material cost will further benefit the bottom line (of small-cap companies in context),” says Amar Ranu, Head - Investment products & insights, Anand Rathi Shares and Stock Brokers.
The key differential over here is pockets of opportunity and outperformances. “Small and mid-cap space is where one can hope to gain alpha (make profit) and hence stock wise moves and outperformance can happen through the year,” says Deepak Jasani, Head of Retail Research at HDFC Securities who however points out that the Nifty may outperform the mid and small-cap space in a few months or quarters.
Valuations of small-cap indices are higher than the Nifty, as these indices may include some loss/small profit-making companies and also the growth rate in earnings overall is faster than that in the Nifty. Lower float value and lower institutional participation/holding in the small and midcap space may also be the reason for higher valuations in these spaces.
How to navigate the tricky smallcap ocean
“The key aspect or challenge to look at while investing in a small cap stock is, the nature and quality of data available in the public domain, from the point of view of information,” says Sriram BKR, Senior Investment Strategist at Geojit Financial Services.
The challenge to an extent remains, even if one turns towards a research house or recommended stocks from a broking house. Many fund house reports suggest that small caps are a less researched universe. The average analyst covering stocks would be less than a large-cap universe. Hence from a retail investor's point of view, the deciding factor for them would be the clarity and confidence in stock picking.
How to approach the conundrum
“Rather than thinking about investing into small caps per se, an investor should think from an overall portfolio perspective and maintain the allocation spread across large-cap, mid-cap and small-cap. Ideally, one should maintain a mix of 50-60% in large cap and 20-25% each in mid and small cap at any point in time. However, given the opportunity and valuation, one may increase the allocation towards small cap tactically,” strategizes Ranu.
“For a resilient long-term portfolio, consider allocating 20% to small-cap funds, ensuring a 7-year plus investment horizon. This strategic approach balances growth potential with risk management,” says Shrestha.
So that takes care of the percentages and the timeframes, but how to go about the actual investment into small-caps for the retail investor?
“If the investor thinks even for a moment that it would be a very challenging exercise, it is advisable to approach small caps through the MF route, where you have certain rules and processes in place for stock selection, diversification and also controls in terms of single stock exposures, etc,” says Sriram.
“Rather than picking stocks in small-cap space, it is prudent to take exposures through the MF route,” advises Ranu. Here you go through multiple filters of selecting the best stocks through the professional management route which reduces the accidents and the overall volatility in the portfolio.
Also, if one does not have expertise in equity research or is not a keen balance sheet reader, it is best to leave the money with professional managers to manage the fund for us.
But, even while investing in the small-cap sector vis-à-vis MFs you have to take a call on actively managed or passive funds based on your investment style.
“Information arbitrage is still high in small cap space due to many reasons like smaller number of analysts tracking small-cap companies, prone to market asymmetry and picking the right stock/sector at right time,” says Ranu, who suggests actively managed funds where the managers have fund management skills.
Last one year, the small-cap category funds have shown impressive returns; however, only 25% of actively managed small-cap funds have outperformed the benchmark index.” Given this, for retail investors, adopting a passive small-cap fund through a Systematic Investment Plan (SIP) may be a more prudent approach,” says Shrestha.
“Within passive funds instead of investing passively in the whole segment of small caps, we can consider certain rule-based smart beta funds which can assist to reduce the risk of capital loss by choosing good quality companies with better fundamentals and endeavour to keep wealth destroyers away to a great extent,” says Ghelani, who notes that while actively managed funds can certainly beat the benchmarks, identifying such funds is a challenge.
Further, one key advantage of such passively managed smart beta funds would be that there would be no human bias involved which is often very important in the small-cap segment. “Such passively managed funds would also be available at a much lower cost as compared to active funds,” says Ghelani.
External environment and your small caps: Small caps are more vulnerable due to their relatively limited resources and market capitalization, making them sensitive to external shocks. These factors can disrupt supply chains, raise operational costs, and heighten uncertainty, disproportionately affecting smaller companies that may lack the resilience and diversification of larger counterparts in navigating such challenges.
Manik Kumar Malakar is a personal finance writer.
Catch all the Instant Personal Loan, Business Loan, Business News, Money news, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
Business NewsMoneyPersonal FinanceSmall-caps: Pockets of opportunity or minefields on the equity bourses? 5 experts weigh in
First Published:26 Dec 2023, 10:04 AM IST
- Top Gainers
- Top Losers
- 52 Week High