scorecardresearchShould small-cap investors be cautious about making further investments

Should small-cap investors be cautious about making further investments in the market?Experts answer

Updated: 13 Jul 2023, 11:39 AM IST

Why are AMCs clamping down on lump sum investments in the small-cap category? Is there a reason to fear a possible bear run in the small-cap segment?

Some small-cap stocks have higher PE ratio than others, thus, explaining the inherent risk involved in investing in funds containing these stocks.

Some small-cap stocks have higher PE ratio than others, thus, explaining the inherent risk involved in investing in funds containing these stocks.

There is something brewing in the small-cap world. Mutual fund houses are apprehensive about accepting more investments into their small-cap funds. First, the Tata Small Cap Fund stopped accepting lump sum investments from its investors. The Nippon Small Cap Fund soon followed suit as they directed their investors to continue putting their money through small investment plans (SIPs) instead of allocating money into this fund in one go.

This choice has the potential to generate inquiries among both experienced and novice investors, leading them to explore the specifics and consequences of this action. Is there a reason to fear?

Truth be told, there is not one asset management company (AMC) not looking for investors’ money. What then prompted some of the biggest mutual fund houses to say “No” to investors’ money pumping their earnings into small-cap funds? There is no doubt that small-cap funds benefited most from investors’ money compared to other market-cap funds.

As per the data released by the Association of Mutual Funds in India (AMFI), the net inflow of money from January to March 2023 into the small-cap fund category amounted to 6,932.19 crores. This is huge when compared to investments in other fund categories. The net inflow into the small-cap sector from April to June 2023 amounted to 5,101.68 crores.

The market is at an all-time high, thus, triggering the fear of a sudden crash or meltdown. With so many overvalued stocks, especially in the small-cap sector, there is a fear of this sector being at the receiving end of the impending crash. Apart, many small-cap stocks have graduated to mid-cap stocks, thus, leaving not too many companies in this sector to be invested in. What does this signify for the small-cap sector?

Dev Ashish, Founder, Stable Investor said, “While markets making a new all-time high doesn’t necessarily mean a correction or fall in the near future, it definitely makes sense to review your portfolio. If asset allocation has changed and equity allocation percentage has gone beyond chosen tolerance range, then it makes sense to rebalance the portfolio. This may feel odd to many as they may feel like why leave the party before it’s over (i.e., why reduce equity when it is giving great returns), but that is how proper portfolio management needs to be. Periodic reviews are very important. With regards to the rally in the small-cap side of the market spectrum, what is happening isn’t something new. Small-caps are known to give great returns once every few years and then take a breather. That is the nature of small caps. So, if the portfolio’s small-cap allocation has also increased beyond comfort levels, then one needs to relook, review and rebalance it back to saner levels now.”

Small-cap funds’ performance has been impressive, especially, in the last three years. Take the statistics on MoneyControl, and you will realize how the three-year average returns reached an impressive 41.60 per cent with Quant Small Cap Fund, Nippon India Small Cap Fund, and HDFC Small Cap Fund performing consistently since their inception.

The volatility in these funds is no doubt inherent. However, the lucrative returns offered by most of these funds have caused them to be included in most investors’ portfolios. However, the recent development underlines a fear of being affected by the forthcoming market movements.

Viral Bhatt, Founder, Money Mantra shared, “Yes, I do foresee some reasons for small-cap investors to be warned against investing in the current market.

One, the PE ratio of the small-cap sector is high. This means that investors are paying a lot for each rupee of earnings that these companies are generating. This can be a risky proposition if the earnings of these companies do not grow as expected.

Second, the market has already touched a lifetime high. This means that there is a risk that the market could be due for a correction. If the market does correct, small-cap stocks could be hit particularly hard.

Third, small-cap stocks are more volatile than large-cap stocks. This means that their prices can fluctuate more wildly, which can make them riskier investments.”

Rajani Tandale, Product Head – Mutual Fund, 1 finance added, “The Nifty small cap index has displayed remarkable performance with approximately 15 per cent returns over the past six months and an impressive 30 per cent returns over the last 1 year. This significant rally in the small-cap space has attracted increased investor participation. In the last year alone, the net AUM inflows in the small-cap category surpassed 65,000 crore. Although the markets are currently trading at all-time highs, it is noteworthy that the current PE ratios of the Nifty small cap 100 index are around 20, compared to approximately 18 in January 2023. This suggests that fund managers are more concerned about the liquidity of small-cap stocks rather than their valuation.”

Tandale added, “Some of the AMCs have restricted lumpsum investments in their small-cap funds because deploying fresh funds in such a scenario would be more difficult. Considering these factors, it is advisable for small-cap investors to exercise extreme caution. Opting for staggered investments, rather than lump-sum investments, is a prudent approach in the current scenario. Else the investors can choose flexi-cap category which changes its allocation based on the market condition.”

Compared to other asset classes, small-cap funds emerged as the category with the highest overall returns, exhibiting only a few underperformers. Harshad Patil, Executive Vice President and Chief Investment Officer, Tata AIA Life Insurance said, “Small-cap stocks are a significant part of the Indian equity market, with more than 4500 companies. Among these, approximately 500 stocks have a market cap higher than 2000 crore. That is why, compared to the large-cap and mid-cap categories, the small-cap category presents a large universe of stocks for investment.”

However, all good things come to an end. Does this mean that the continued market run in the small-cap space will now come to a halt? Are we anticipating a gradual slowdown in the small-cap sector or will there be a resounding crash that will remind the investors how troughs automatically follow the crests and the much-feared bears cannot be in hiding for long? As they say, “Bull markets climb a wall of worry; bear markets slide down a river of hope.”

No one knows what the market holds for each one of us. People who think they know what is going to happen next are fools. The stock market will always throw surprises at us, and some of them will indeed be nasty and desperately unpleasant.

Source: Geojit
First Published: 13 Jul 2023, 11:39 AM IST