Investors see opportunity amid sharp corrections in mid-cap and small-cap stocks
Valuations in mid- and small-cap cooled off due to sharp corrections, which has drawn investors
MUMBAI: Mutual funds are significantly investing in mid-caps and small-caps despite their weak performance, and the risks associated with volatility of smaller companies. According to data released by the Association of Mutual Funds in India (Amfi), while net inflow into large-cap funds in April stood at ₹48.27 crore, for mid-cap funds it was at ₹491.04 crore, and for small-cap funds it stood at ₹955.83 crore. For the first time, Amfi has released granular monthly data for investments by mutual fund houses.
Mutual funds’ preference for mid- and small-caps over large-caps comes at a time when the BSE MidCap and BSE SmallCap indices have been under pressure. BSE MidCap fell 8.56%, while BSE SmallCap lost 6.29% so far in 2019, after slipping 13.38% and 23.53%, respectively, in 2018.
In 2019, the benchmark index, Sensex, has gained 2.9% and the BSE LargeCap index has jumped 1.58%, while both indices gained 2-6% in 2018.
In April 2019, too, the BSE LargeCap index and the Sensex were up nearly 1%, while BSE MidCap and BSE SmallCap were down 3-4%.
Analysts said steep valuations in mid- and small-cap stocks have cooled off due to sharp corrections, providing an opportunity for investors.
“Valuations have come off considerably in mid- and small-caps after corrections, and we believe there is a significant opportunity here to generate alpha. These levels of inflows may not be suitable for small-cap funds that are already too large. However, they can be handled by funds of a small to medium size," said Radhika Gupta, chief executive officer (CEO), Edelweiss Asset Management Ltd.
Valuations of mid-caps, which were considered frothy and had a premium over large-caps till last year, have cooled off significantly. According to Bloomberg data, the BSE MidCap is currently trading at 17.48 one-year forward price to earnings (PE), which is much lower than three-year average of 19.66. The BSE MidCap is trading at 14.78 times PE, while the Sensex is at 17.60.
According to Swarup Mohanty, CEO, Mirae Asset Global Investments (India) Pvt. Ltd, the large gap between small- and large-cap inflows seems to be the result of trend-buying on the part of investors. “Small-caps, as a category, are down 17% over the past year, hence, investors could be blindly contrarian."
Meanwhile, the share of both the BSE MidCap and the BSE SmallCap indices in overall market capitalization has decreased, while that of the Sensex has grown since January. At current levels, the BSE MidCap index contributes 12.77% to India’s total market capitalization, down from 13.72% in January.
In contrast, the contribution of the Sensex to the country’s total market capitalization has grown from 44.87% in January 2019 to 46.18% at current levels.
Typically, domestic institutional investors’ (DIIs) investment is skewed towards the mid and small stocks segment, while foreign institutional investors’ (FII) money largely goes into large-caps. So far in 2019, FIIs were net buyers of Indian shares worth $9.92 billion (approximately ₹6.99 trillion), while DIIs have sold shares worth ₹13,368.4 crore.