Asset managers flag off concerns over steep run-up in mid-, small-cap space

The mid and small cap indices, which lagged large caps until early 2020, have covered lost ground, gaining 73% and 104%, respectively, in the past one year

Asset managers have flagged off concerns over the steep run-up in mid and smallcap stocks, which has shrunk the traditional discount available in the segment vis a vis large cap peers. 

The mid and small cap indices, which underperformed large caps until early 2020, have covered lost ground, gaining 73 per cent and 104 per cent, respectively, in the last one year. 

“The economy is likely to see a cyclical upturn which makes us feel that the outlook for the broader market is likely to be good going forward. However, the euphoric rise in many poor-quality small cap names driven by higher retail participation is a cause for concern,” said Vinit Sambre, head - equities and fund manager, DSP Investment Managers. 

On aggregate, the entire universe of flexi cap schemes, which invest across market capitalisations, had 71.5 per cent of their assets invested in large caps, 23.4 per cent in mid-caps and 5 per cent in small caps as of May 31, data from Value Research shows. 

According to Prashant Jain, CIO at HDFC MF, the widely held belief that small caps grow faster than larger companies may not entirely be correct. “We believe that the same is not borne by data, at least for aggregates, and that the category average returns for large and mid-cap stocks are comparable over long periods,” he said in a presentation to investors of HDFC Flexi Cap Fund on Tuesday. 

Jain said the steep rally in the mid and small cap space had made valuations uncomfortable, which is why the fund had lower exposure to such stocks in its portfolio. The fund (formerly HDFC Equity Fund), the second largest in the flexi cap category, had 14.6 per cent invested in midcaps and 7.4 per cent in small caps as of May 31, 2021. 

Neelesh Surana, CIO, Mirae Asset Management believes that investors’ portfolio should be more skewed towards multicaps and large caps at this juncture and those overweight on midcaps should reduce their exposure. 

“If the risk-adjusted returns between large and midcaps is similar then one should prefer higher allocation towards large caps, which is what the case is currently. Midcaps do offer opportunities on a bottom-up basis, and can form about one-fourth or one-third of overall allocation. Today, however, an allocation over 25 per cent should be reduced. Also, one should avoid small and micro caps at this juncture as these have moved up significantly due to excess liquidity,” he said.

Mihir Vora, CIO, Max Life Insurance, cautions against froth in segments such as chemicals, pharmaceuticals, mid-cap IT and internet-linked and PLI-linked plays within the mid- and small-cap universe. He sees pockets of value in the commodities and construction linked segments, where valuations have been depressed for a long time. 

Harsha Upadhyaya, CIO – equity at Kotak AMC, believes that the profitability cycle is improving and the mid and small cap space may continue to do well if the economic momentum picks up in the next few quarters. Investors, however, may have to temper their returns expectations as a repeat of last year’s rally is unlikely in the immediate future.

“The market is factoring in nearly 40 per cent earnings growth for the current year and any disappointment in this regard will impact stock performance. Investors should also be aware that the volatility in this space is likely to be higher, which is why investments need to be done over a longer term horizon of 3-5 years,” he said. 

Asset managers expect higher market volatility going forward given the US Federal Reserve’s stance on tapering. The global recovery is likely to be faster than that in India because of the impact of the second wave of the pandemic as well as rising prices on account of raw material inflation.