Investing in mid-, small-cap funds? Investors must tread with caution

The recent correction in Indian equities has led to mid-cap and small-cap funds underperforming, weighed against large-cap funds. Participants in the mutual fund (MF) industry observe that the worst is not behind us, and investors must tread with caution.

The data from Value Research reveals that in the past month, mid-cap and small-cap funds have on average fallen 7.54 per cent and 9.77 per cent, respectively. Large-cap funds, however, have delivered negative returns of 5.33 per cent in the same time frame. Expectations of further rate hikes in the months to come and high inflation are likely to keep mid-cap and small-cap stocks under pressure. 

In the past month, the S&P BSE Sensex Index is down nearly 4.31 per cent, while the S&P BSE MidCap Index and the S&P BSE SmallCap Index have given negative returns of 8.58 per cent and 11.4 per cent, respectively.

“Given the significant two-year consistent outperformance, expected market volatility due to the US Federal Reserve rate hike, and concerns over near-term profitability due to limited pass-through of rising raw material price, it is prudent to adopt a cautious approach while making fresh allocation in mid-cap and small-cap funds at the current levels,” said ICICI Direct Research in its report on MFs.

Barring the past few months, small-cap and mid-cap funds outperformed significantly, compared to other categories until the start of calendar year 2022. In the past two years, mid-cap and small-cap stocks had seen a sharp rally on the back of government policy measures, such as production-linked incentive schemes across sectors and lower interest rates.

With positive performance, investors have reposed faith in such funds. As of March this year, net assets of mid-cap funds stood at Rs 1.59 trillion, compared with Rs 1.16 trillion in March 2021. Assets of small-cap funds increased to Rs 1.06 trillion in March, from Rs 69,799 crore in March 2021.

G Pradeepkumar, chief executive officer, Union Asset Management Company, says, “We still prefer large-cap over mid-cap and small-cap funds. Investors who want to invest long term in mid-cap and small-cap stocks should have a staggered approach since volatility is likely to remain high for some more time.”