Mid-, small-cap funds continue to disappoint investors amid market meltdown

Broader market indices hit 2.5-year lows after falling over 11% in July

Mutual fund (MF) investors — who had increased allocations to mid- and small-cap funds after the Lok Sabha election outcome in May — have been caught off-guard as the returns for these categories have taken a sharp beating in the ongoing market meltdown.

So far this month, the two categories delivered negative returns of 7-8 per cent, according to data sourced from the Association of Mutual Funds in India. On Tuesday, broader market indices — NSE Midcap 100 and NSE Smallcap 100 —ended at their lowest levels in 30 months and 32 months, respectively. Both the indices have lost more than 11 per cent in July amid fears of rising corporate defaults and sell-off by overseas investors.

According to fund managers, investors betting on these categories would need to brace for medium-term volatility. “Growth has continued to languish. Earnings are not picking up. Moreover, the Budget proposal on surcharges in July triggered heavy selling by foreign institutional investors (FIIs), worsening the sentiment,” said Akash Singhania, senior vice-president and fund manager of Motilal Oswal Asset Management Company.

Spooked by the increase in tax surcharge, foreign portfolio investors (FPIs) have pulled out over Rs 12,000 crore since the Union Budget, weighing on stock prices. The FPI pull-out this month is likely to be the most in nine months.

In May, investor appetite towards mid- and small-cap funds seemed to have returned with a sharp uptick in flows. These funds cornered Rs 2,687 crore of flows in May, accounting for 49 per cent of equity flows. The returns also saw an uptick, with certain mid-cap schemes delivering 3-5 per cent returns. In the case of small-cap funds, some schemes managed to even deliver 5-6 per cent returns. Market players say flows into this segment could drop to even lower levels after this month’s disappointing performance. In June, investor flows in mid- and small-cap funds had dropped 34 per cent with mid-cap funds delivering negative returns of 1.4 per cent and small-cap funds seeing negative returns of 3 per cent.

“There was always a risk of these flows reversing as investor allocations to mid- and small-cap funds rose on fear of missing out on a broad-based rally. In July, the returns have fallen further below investor expectations and this could make a major dent on the flows,” said a fund house executive.

However, fund managers feel this could be an opportune time to build positions in mid- and small-cap funds.

“For the next 3-6 months, investors can look at building up their positions. The divergence between the Nifty and mid- and small-caps is at historical extremes. While it is difficult to spot the bottom, historically broader markets tend to outperform for 18-24 months after such extremes are reached,” said Pankaj Tibrewal, fund manager at Kotak MF.  “Quality names in the mid- and small-cap space are looking interesting post-correction,” said V Balasubramanian, chief portfolio strategist- equity of Mahindra MF.  Analysts add moderating interest rates is also a positive for mid- and small-cap companies as debt plays an important role in funding requirements of these firms.