Small-caps off to the best start in four years; surge more than 25%

Outperformance to Nifty sharpest in more than a decade

Companies in the sm­all-cap universe are having a dream run — the Nifty Smallcap 100 index has shot up more than 25 per cent on a year-to-date basis, even as the benchmark Nifty is up 7 per cent. 

This is the best start for the index since 2017 when the Nifty Smallcap 100 index surged 32.3 per cent between January 1 and May 10. However, in terms of outperformance to the Nifty, this year’s performance is the best in more than a decade.

A combination of sectoral tailwinds and lack of institutional selling pressure has helped small companies escape from the correction triggered by the second wave of Covid-19.

Another aspect underpinning gains in the small-cap index is that while the Nifty and the Nifty Midcap 100 indices have hit new all-time highs this year, the Nifty Smallcap index still trades below its 2018 peak. 

Small-cap companies belonging to sectors like metals, chemicals, and pharma have done well this year.

“Commodities and material space, including metals, sugar, and cement, did well due to the boom in commodities and inelastic supply. New-age businesses like mobile advertising and third-party outsourcing caught the fancy of traders and investors. Chemicals and CGD (city gas distribution) stocks also did well due to the China+1 policies followed by global buyers and the spread of gas distribution across the country," said Deepak Jasani, head of retail research, HDFC Securities.

In contrast, stocks in the banking, financial services and insurance (BFSI) space -- which has a high weighting in the large-cap indices -- lagged, weighing on the performance of the benchmark indices.

BFSI companies provide credit to stressed sectors and this pushed investors to prune their exposure to this space.

Analysts said the reflation trade was still playing out in small and mid-cap stocks. "When the economy grows sharply from a low base, mid- and small-cap companies tend to do better. They are at a small base and growth is much high­er," said Siddhartha Khemka, head of research-retail, Motilal Oswal Financial Services.

The relatively cheap valuations in the mid- and small-cap space are also helping such stocks attract more investors.

The selling by foreign portfolio investors (FPI) have affected large-caps and index stocks. In contrast, mid- and small-caps do not have much institutional selling pressure. The low base of earnings for small- and mid-caps has enabled them to grow faster than their larger counterparts in the pandemic-induced disruption, said analysts.

The advent of first-time retail investors who started trading last since April last year also helped mid- and small-cap companies. Retail investors usually prefer mid- and small-caps over large-cap stocks.

"The institutional holding and float stock in small- and mid-caps are much lower than those in large-caps. The new crop of investors signed up over the past year or so bet on small- and mid-cap stocks as they felt they can generate alpha by investing in these stocks. Even some mutual funds are increasing their small and mid-cap exposure,” said Jasani.

Analysts said this outperformance is likely to extend until the end of this year.

"A couple of months of this lockdown will pull down economic growth to an extent, which will be a cause of concern for FPIs. On the other hand, retail investors will continue to invest in broader markets," said G Chokkalingam, founder, Equinomics.

Jasani said small and midcap stocks did correct but rotationally, and hence the impact on the indices was limited.

"These spaces are high-beta compared to the Nifty. Hence, in a secular downturn, we may see them falling more than large-caps. As long as these stocks give out positive news and results, they may continue to rise due to the heightened participation of HNIs and retail investors. "