Investors seem to be betting on riskier asset classes for higher returns, with continued net outflows from large-cap equity funds since the past three months. Net outflows stood at Rs 5,291 crore for May-July.In contrast, investments in small-caps have been rising, with a combined Rs 12,925 crore in net inflows during May-July. Net inflows came in consistently above the Rs 3,000-crore mark during the three months.Experts say both foreign and domestic flows in the category have been coming in at nearly 2x the average monthly flows, since a few months.
“Investors are focusing increasingly on mid- and small-caps where valuation is costly, and less on large-cap, multi-cap, and flexi-cap strategies, which are relatively safer options in the current market conditions. There is a boom happening in mid- and small-caps, which leaves open the scope for a correction in the medium term. The near-term is likely to be held up by very high flows,” said S Naren, ED and CIO at ICICI Prudential MF.Indeed, while the Sensex and Nifty have returned close to 7% year-to-date, the mid-cap and small-cap indices have shown returns of 23% and 27%, respectively.Investors clearly seem to be following the trend and heading towards the promise of higher returns, notwithstanding the higher volatility in such stocks. Fund managers say small- and mid-caps typically grow faster than larger names in a growing economy.“Momentum money chasing the past twelve-month returns has turned towards small- and mid-caps, fuelling further returns. These typically offers a wider set of stocks for participants to invest in, and are generally less covered by analysts which is why the element of surprise is larger,” said Devendra Singhal, executive vice-president, Kotak MF. Agrees Mahesh Patil, CIO of Aditya Birla Sun Life AMC, saying the rally has been broad-based, with many sectors participating. Factors such as capex and infrastructure development, PLI schemes, etc have helped markets reach their highs.“Approximately 83% of Nifty 500 stocks were above their 200-Day Moving Average (as of 31 July). The contribution of the MidCap Index to total market cap (in %) is at a two-year high. However, relative valuation of Mid and Small caps, versus large caps, is still lower than historical levels,” said Patil.This begs the question, is the trend likely to continue?After the recent rally, says Singhal, the expansion of multiples in small- and mid-caps has been pretty sharp. The relative valuation gap with large-caps has reduced meaningfully, he added, as a result of which large-caps should be preferred over small- and mid-caps in the near term.Some say with the Indian economy better placed than peers, foreign investors are betting big, which saw an inflow of $19 billion into the equity markets in FY23 alone. Patil pointed out that corporate sentiment is at a two-year high, going by guidance on margins, costs, inflation, and commodity prices. Thanks to continuous improvement in high-frequency indicators, investors are confident of the domestic focused sectors, leading to the increased interest in mid- and small-caps.However, this is not to say that betting on large-caps is the only correct strategy. Mid- and small-caps show better growth possibilities over the medium-to-long term, and should be part of an investor’s portfolio, says Singhal.Average returns by large-caps were 3.45%, 3.98%, and 3.83% as of July, June, and May, respectively.In comparison, average returns by small-caps stood at 6.14%, 5.90%, and 5.64%, while that for mid-caps was 5.25%, 5.59%, and 5.64% at the end of July, June, and May. While the returns seem to justify investors’ increasing faith on the categories, one should not lose sight of the risk at hand, fund managers opine.“For investors, the cornerstone of investment must be asset allocation and clarity of overall risk levels. Once this is clear, investors are better equipped to deal with the volatility in small- and mid-caps. The greed to make quick money also takes investors away from their objective and pre-decided risk levels,” warned Patil.Indices correcting from their July highs point towards a correction and some volatility in the near term. The cue for investors, say experts, is to think long-term and limit their risk-taking.Singhal says there are various phases of the market — from pessimism to exuberance — and it all plays out over a cycle. Investors would do well to look long-term for their hard-earned money to grow.Rising maturity and patience among investors, thanks to higher awareness, is keeping the industry upbeat. Experts say investors today are willing to see complete market cycles with their investment in small and mid-caps.The SIP has become one of the favoured vehicle for investments in this segment.“SIPs in these funds is a better approach as fund managers are monitoring the various underlying investments on a regular basis,” says Patil, pointing out that the trend may get worrying if investors are not aware of their risk-taking capabilities.Eventually, this leads to hasty decision making, which results only in fingers getting burnt.