Investing in small-cap, mid-cap and large-cap have nothing to do with the market scenario. It has to be more in line with your risk appetite.
The small and mid-cap segment witnessed a dream run in 2017. However, things did not remain picture perfect. Since Jan 2018, the small & mid-cap has seen a lot of battering since Jan 2018. Nifty Small-Cap 100 has seen a steep fall of approx. 35%, while the drop stands at approx. 23% for Nifty Midcap 100 segment. On the other hand, BSE Sensex large-cap index soared by approx. 8% until July 2019.
Mid-cap and small-cap stocks are bleeding in my portfolio. Which are the reasons that are causing a trouble in the paradise of small-cap and mid-cap universe?
The reasons are multiple: Corporate governance issues (Remember the infamous case of Vakrangee and Manpasand), the reclassification norms for mutual funds, IL&FS and DHFL crisis and obviously the recent announcement of the minimum public shareholding of 35%. This all factors and a few more led to a transient liquidity challenge in India. Hence, even many small & mid-cap businesses that displayed consistent valuations and performance are going through subdued response and low-interest levels by the retail investor. In simple terms, we have more customers with less stomach to withstand the risk, and that’s why more investors are selling than buying.
Due to the ongoing mayhem in small-cap and mid-cap, many investors are reconsidering their exposure to this segment, while few are contemplating whether the risks associated with these stocks will translate into decent returns in the future.
Ok, wait a minute…But what are mid-cap and small-cap stocks?
To get started, the mid-cap universe of stocks represent businesses that rank 101 to 250 based on their market capitalization. The small-cap world includes stocks that populate the ranks 251 to 500 based on the market capitalization. Because mid-cap falls between large-cap and small-cap stocks, they are not as risky as small-cap and comparatively has more muscle to withstand slowdowns as compared to small-cap. Similar to small-cap stocks, they also have a high potential to grow when the economy is flourishing, and interest rates are low. To summarize, the large-cap segment represents stocks of established and stable businesses, while mid-cap and small-cap consist of stocks that are more volatile and susceptible to economic downturns.
Considering the slump in the mid-cap and small cap stocks and when the economic is suffering from liquidity issue and FII outflows, should you still invest in them?
Firstly, the Nifty mid-cap and small-cap are down only by 10% and 8% respectively from the start of the year. The fall of 8-10% is not a crash, so retail investors can hold some breath here. Obviously, the fall is steeper if you compare from 2018 highs. However, if you look at a longer horizon, Nifty generated 72.93% returns between FY2014-19, while Nifty Mid-cap delivered 112.01% and Nifty Small-cap delivered 80.20% in the same period. While the performance have not been so impressive over the last 1.5 years, the story was not always the same!
Also, the stock market is all about cycles. Few years are bumper, few are muted, and few can give you nightmares. So if you have a stomach to ride this volatility, the answer is YES. But if not, forget equities (Don’t even think about small-cap and mid-cap also in this case). The reason is – during the economic boom, these stocks tend to give a higher return, while in cases of downturns, the fall is steeper as compared to large-cap stocks.
If I want to invest, where should I?
There are many high-quality small-cap and mid-cap stocks that are rich in valuations, display consistent cash flows and earnings as well as helmed by strong leadership. And, this is where you need to invest!
Many investors believe that they will strike gold by investing in small-cap and mid-cap stocks. As they are not as expensive as large-cap stocks, they buy them as lottery tickets only to see their hopes getting vanished later. Yes, it is easy for a stock price at Rs. 100 to become Rs. 200 as compared to Rs. 10,000 stock to become Rs. 20,000. However, many companies never recovered from the fall and are now reduced to penny stocks. Plus, TV and the internet is bombarded with stock recommendations. However, one should only invest when they know where and why they are investing. Unless you are aware of this, forget investing in the stock market.
Now tell me how should I invest in these stocks?
Investors who are looking forward to building a well-diversified portfolio of small-cap, mid-cap and large-cap should take exposure in small and mid-cap via the Systematic Investment Plan (SIP) route. Starting SIP and continuing it in a disciplined fashion will help investors average their cost and benefit them in the long run. Talking about the asset allocation, it purely depends on your risk appetite and nothing to do with the market scenario, as generally believed by many investors. There is no thumb rule on ideal asset allocation, as everything depends on your level of risk tolerance i.e. how much risks you’re willing to take to generate alpha.
Now tell me, where these stocks are headed…
We expect government to take adequate steps to arrest the economic slowdown, address liquidity concerns, address problems plaguing various segment of economy and target other economic prerogatives by giving a push through various reforms. If this happens (which we are sure about), the economy will flourish and many opportunities will be unlocked.
Rest, you know, what will happen to the mid-cap and small-cap stocks.