Investors seem to be enthused by the rally in mid- and small-caps, but fund managers advise caution against taking excessive exposure despite opportunities for growth.
According to experts, while the rally is justified in certain pockets, it’s just a euphoric move in others. The BSE MidCap has seen a stellar 119.5% rise over the past three years, and 115.3% over the past five years. Year-to-date, it has gained 27.63%.
Mid-cap funds have returned an average of 29.8% over the past three years on a CAGR (compound annual growth rate) basis. The best performing ones have given upwards of 35% returns. On a five-year basis, the average has been 17.5%, with the top performers giving over 20%.
Given the consistent showing over the longer term, there might be merit in the view that the rally is not completely ‘irrational’.
“Sometimes, large-caps outperform while small and mid-caps go through a period of consolidation, and vice versa. However, it is important to have exposure to all segments while creating a portfolio, so small- and mid-cap stocks must be considered part of the allocation strategy. We have seen small and mid-caps outperform the overall market over the long term. At the same time, asset allocation should be kept in mind,” said A Balasubramanian, MD and CEO of Aditya Birla Sun Life AMC.
Mahesh Patil, CIO of Aditya Birla Sun Life AMC, adds: “There has been growing enthusiasm for small-caps over the past few months. After the sharp run-up, we believe some stocks in the small-cap universe have run ahead of fundamentals and one needs to be cautious here. However, with the corporate earnings growth cycle looking positive, there are opportunities with favourable risk/reward for a discerning investor. Investors with a disciplined asset allocation will do well in the long term.”
Small-caps, too, have impressed as far as returns are concerned. On an average, the return has been 35.3% over a three-year period, going as high as 42% in the case of the best performing funds. Over five years, the average has been 20.5%.
The BSE SmallCap has jumped 30% YTD. On a three- and five-year basis, the index has surged over 150%.
This points to a clear momentum in small-cap funds. However, some say the valuations are high beyond reason, and large-caps still remain the ‘safe’ bet in the current environment.
“Sharp moves in select small and micro-caps in excess 20-30% a month, driven by flows, bunching up IPOs, and offers for sale by companies and promoters, all point to ‘momentum chasing’ by investors, thus leading to misallocation. Select stocks and sectors have reached valuations that reflect ‘moonshot’ growth rates to sustain for a long time, which can be risky,” says Sailesh Raj Bhan, CIO (Equity Investments), Nippon India Mutual Fund.
Large-caps look the better option to mitigate risks in the current environment of elections, high interest rates, and rising oil prices, he pointed out.
Data shows that large-caps have given 21% returns over three years, while on a five-year span the return has been 12.5%. While mid- and small-caps have clearly outperformed, asset allocation should not depend on returns alone, say others.
“Investors should not decide future investments based on past returns of equities, or returns of any specific category of equities. We prefer large caps vis-à-vis mid/small-caps at present, as the relative valuations are expensive for mid- and small-caps,” said Harsha Upadhyaya, CIO (Equity) of Kotak Mutual Fund.