In recent years, small and mid-cap mutual funds have been experiencing an increased investor interest and fund inflows. As of August 31, 2023, the net assets under management (AUM) for small-cap mutual funds have witnessed 342 percent increase since March 31, 2020, compared to 219 percent for mid-cap funds and 100 percent for large-cap funds. This influx of liquidity, coupled with valuations and the promise of future profit and market share growth, has ignited a bullish sentiment towards small and mid-cap funds.
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Commenting on this, Anurag Jhanwar, Partner and Co-Founder at Upwisery Private Wealth said; "The quantum of liquidity chasing these sectors apart from PMS, AIFs and direct stock exposures coupled with attractive valuation, expected profit and market share growth over the next 4-5 years has led to the bullishness towards small and mid-cap funds."
According to Jhanwar, the ongoing economic activity is leading to earning and revenue growth towards the mid and bottom profile companies, which have the potential to post strong and consistent earnings growth along with gaining significance in their sector or area of expertise.
"Also, the investor segment has started to realise that this segment has the potential to provide healthy returns in the long term and started allocating higher portion of their capital to this segment. So, the long term story is very strong, but investors should be cognizant that the themes might take long time to play out and reflect in the stock prices," he told CNBC-TV18.com.
Also, if we look at the data set closely, small cap funds have relatively underperformed other category of funds over the last 5 to 7 year period and therefore, the rally we are seeing currently might be more of a catch up to be done to be at par with historical trend.
(Source: Upwisery Private Wealth)
Exposure to small and mid-cap
As per Jhanwar, investors should follow asset allocation exposure diligently and have allocated to various category of funds according to the asset allocation suiting their risk profiles.
"In terms of market performance, the small cap indices are still trading at lower end of their historical PE average and investors should take a gradual exposure to this segment and maintain overall asset allocation limits," he told CNBC-TV18.com.
Multi-cap as an alternate way to take exposure to small and mid cap
The Multi-cap funds are diversified across large-cap, mid-cap, and small-cap stocks i.e., 25 percent in each. This can help to reduce risk, as different market caps tend to perform differently at different times.
Jhanwar said that this sectoral exposure restriction can allow multi-cap funds to incrementally adjust the 25 percent to market caps which they feel are better suited to ride the market volatility. This is not possible to be done in case of a pure play small cap or mid cap funds, where they have to keep minimum 65 percent invested in the specific sector stocks.
Value in small and mid cap beyond this peak
There is always value to be found in good stocks that have solid fundamentals.
"If we look at the historic PE of the Mid cap and Small cap index since 2008, we have seen trend of Average PE settling at higher trajectory over a block of 5 year or so. If we go by this data point, it provides comfort that in the longer term we will see growth. However, if look at the average PE of the index since 2008, we can say that while midcap index is hovering around its average, the smallcap index PE is still trading at a huge discount to its average, which implies headroom for growth," Jhanwar said.
This might not be the peak as well yet. Historically, median PE of mid-cap and small-cap indices is around 26 and 40 respectively.
| Calendar Year | Nifty 50 (%) | Nifty Next 50 (%) | Nifty Midcap 150 (%) | Nifty Smallcap 250 (%) | Nifty 500 (%) | Nifty Microcap 250 (%) |
| 2008 | 19.01 | 14.23 | 13.24 | 14.48 | 16.39 | 12.16 |
| 2009 | 20.18 | 14.89 | 17.38 | 14.75 | 18.80 | 16.61 |
| 2010 | 22.78 | 17.15 | 19.41 | 17.90 | 20.08 | 15.98 |
| 2011 | 20.22 | 15.17 | 16.27 | 13.97 | 18.61 | 11.54 |
| 2012 | 18.19 | 16.11 | 16.42 | 22.42 | 17.97 | 13.31 |
| 2013 | 17.86 | 17.10 | 16.61 | 38.37 | 17.63 | 12.46 |
| 2014 | 20.43 | 20.21 | 19.35 | 26.04 | 21.08 | 14.41 |
| 2015 | 22.50 | 21.69 | 27.44 | 39.39 | 23.99 | 18.64 |
| 2016 | 21.68 | 25.08 | 32.45 | 90.33 | 24.94 | 33.73 |
| 2017 | 24.84 | 29.01 | 41.27 | 101.67 | 28.23 | 51.16 |
| 2018 | 26.34 | 37.91 | 49.08 | 86.72 | 30.86 | 80.70 |
| 2019 | 27.70 | 43.19 | 31.71 | 41.60 | 29.56 | 138.05 |
| 2020 | 28.39 | 40.69 | 29.00 | 54.13 | 31.31 | 60.06 |
| 2021 | 28.53 | 31.08 | 34.65 | 36.94 | 30.37 | 41.99 |
| 2022 | 21.34 | 21.74 | 25.85 | 20.25 | 22.41 | 35.49 |
| 2023 YTD | 21.62 | 26.16 | 24.95 | 18.92 | 22.61 | 27.66 |
| Average | 22.60 | 24.46 | 25.94 | 39.87 | 23.43 | 36.50 |
(Source: Upwisery Private Wealth)
Increase allocation or not?
Whether or not it is the time to increase the portfolio allocation to small and mid-cap funds depends on a number of factors, including the asset allocation framework, risk tolerance, investment horizon, and financial goals.
"Small and midcap funds are generally riskier than large-cap funds, as they invest in smaller companies with less established track records. However, they also have the potential to generate higher returns over the long term.
If an individual has a high risk tolerance and a long investment horizon, he/she may want to consider increasing the portfolio allocation to small and mid-cap funds. But it is important to ensure that the investment goals are aligned with the risk tolerance and investment horizon. If someone has a short-term financial goal, such as saving for a down payment on a house, he/she may want to avoid investing in small-cap and mid-cap funds," Jhanwar suggested.
(Edited by : C H Unnikrishnan)
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