Emergence of Mid-cap and Small-cap funds in India

The investment scenario in the country has undergone a massive change as the total market capitalization recently surpassed the $4 trillion mark. Individual investors are increasingly buying equity of Indian corporates by investing directly in stock market and more prominently through Systematic Investment Plan (SIP’s) in mutual funds and Unit Linked Insurance (ULIP) plans.

The AUM of the Indian MF Industry has grown from 9.03 trillion as on January 31, 2014 to 52.74 trillion as on January 31, 2024 around 6 fold increase in a span of 10 years.The Indian Insurance market is expected to reach US$ 200 billion by 2027 and the country is the ninth-largest life insurance market globally. As per the Insurance Regulatory and Development Authority of India (IRDAI), India will be the sixth-largest insurance market within a decade, leapfrogging Germany, Canada, Italy and South Korea.

By investing in mutual funds & ULIPs, retail investors are looking at maximizing long term wealth creation through a diversified portfolio of Large Cap (top 100 companies by full market capitalization), Mid Cap (top 101st to 250th company by full market capitalization) & Small Cap (251st onwards company by full market capitalization). While Large Cap companies are well established businesses with significant market share, however, MidCap and SmallCap companies with significantly higher growth potential have seen substantial investments coming in recent time. This is evident from the fact that Midcap companies now account for 18% of total market capitalization as compared to 12% in 2013. MidCap&Smallcap segment has higher representation of companies which are domestic-focused and they tend to benefit more when the domestic economy witnesses higher growth. Here's a breakdown of the key differences between small-cap, mid-cap, and large-cap companies.

Talking specifically about Smallcap landscape, there are many companies amongst this set which are growing strongly, capitalizing on growth triggers in various parts of the economy. These companies are typically more agile than large caps when it comes to growth and responding to changing business dynamics. 

Let’s delve deeper into the investment landscape and the direction in which small-cap investments are headed to from an Indian perspective:

How can small-cap investments be game changers?

There are numerous factors (both historical and potential) that elaborate on why these investments could be critical for any portfolio:

     Small-cap investments have provided higher average returns and sectoral diversification

Besides providing higher returns (up to 30% per annum in the case of a few MFs), small caps provide a range of exciting industries to pour money into. At the same time, NIFTY Small Cap 100 Index returns are close to 70.9% for the previous period. Hence, these investments could be the perfect choice for investors seeking to create long-term wealth.

In the recent Union Budget, the FM talked in detail about the opportunities in railways, infrastructure, and power generation, especially for small-sized enterprises. As the Indian economy continues to thrive, banking on various reforms such as land reforms, power reforms, GST implementation, Jan-Dhan-Aadhaar-Mobile (JAM), RERA, Make In India, etc., these agile small cap enterprises are expected to surpass growth estimates. 

     Small-cap companies have outgrown expectations to transform into large cap investments.

There are numerous examples of companies such as Eicher Motors, TVS, Titan, and Bajaj Finance growing from small-cap to large-cap investments, providing significant appreciation to the initial investors. Investing in small-cap funds presents remarkable growth potential. Consider Titan Shares: a ₹10,000 investment in 1993 burgeoned to ₹43.47 Lakh by 2024, reflecting a phenomenal 43367% return with a 21.6% CAGR. This historic success underscores the lucrative opportunities inherent in small-cap investments for discerning investors. As small-cap investments have a higher degree of exposure to reforms and macroeconomic developments, the cyclical and global risks are largely eliminated. 

     Higher opportunities but a lesser number of explorers

With supportive domestic market and government schemes, small-cap companies have myriad opportunities. Despite the opportunities and potential of the segment, only a small number of explorers and researchers try to analyze such funds or stocks. Any analyst does not analyze around 415 small-cap stocks, thereby providing a massive window for investment. 

Summing up

The very nature of small-sized company makes them an exciting investment alternative as the growth and expansion rates are relatively more than the other alternatives. Keeping in mind of the Emerging India theme, the government support (with latest schemes and benefits offered to small sized companies) and the formalization of the economy, there is a significant opportunity for small cap companies to expand their horizons. With the Indian economy expected to take off in the next decade, this could be the perfect time to invest in the small-cap investment alternatives.