Leading fund managers on how to cope with the mid- and small-cap meltdown

The correction in this space, which began in January 2018, seems to have accelerated recently. Top fund managers advise retail investors to accumulate quality stocks and wait for the upturn

“A good time to accumulate” -- Vinit Sambre, Head of equities, DSP Mutual Fund

Vinit Sambre of DSP Mutual Fund

The correction in small- and mid-caps started at the beginning of 2018. One reason was that valuations had gone up significantly by the end of 2017, even for companies that were not so strong fundamentally. As earnings downgrades continued, the NBFC crisis hit the broader economy towards the end of 2018 and the liquidity situation worsened, small- and mid-cap stocks were hit harder due to their inherently more volatile nature.

The lack of growth stimulus and imposition of higher taxes in the Budget, too, have had a bearing on overall sentiment, leading to further correction. Many stocks within the small-cap index have corrected 60-90 per cent since the start of 2018.

Till growth recovers, returns may be hard to come by. It is difficult to predict how long this situation will last, since recovery will depend on a variety of factors like improvement in the liquidity situation, employment levels and peoples’ spending capacity.

But we have witnessed such downturns several times in the past—in 2000, 2008, 2011 and 2013—so investors should not be unduly worried.

The key issue in this category is the timing of investors’ entry. In the recent past, large inflows began in 2015, when the bulk of returns had already been made in 2014. Investors tend to chase what has already become popular. In 2016 and 2017, they poured more money when the category had already entered the expensive zone.

Prices have corrected now. Very soon they may enter the reasonable zone. Once that happens, start investing gradually and wait for better times. This is the start of a phase when you should invest, not one where you should expect returns.

The amount of research that retail investors can carry out on their own may not be as rigorous as professional fund managers with teams can. The latter, by and large, also tend to be better at avoiding the riskier names in this space. Hence, avoid investing directly and use the mutual fund route instead. Some of the successful fund managers have created value for investors in this space.

“Do not worry excessively about downturn as all cycles turn” -- Kenneth Andrade, Founder and chief investment officer, Old Bridge Capital

Kenneth Andrade of Old Bridge Capital

The breadth of the market has collapsed. Stocks outside the top 15 have been seeing fresh lows over the past two years. Over the past six months, the economy has seen a dramatic slowdown. Then there is the liquidity crunch which is getting transmitted to smaller businesses in a significant way.

Opt for companies that are not seeing too much stress on their balance sheets. Many stocks are currently trading at five-seven times their earnings. We have reasons to believe that they will bounce back to around 10 times earnings in a couple of quarters. Investors just need to hold on and go through the down cycle. The negative cycle will not be there always, so investors need to be patient.

The entire market has come to a lower plane. Investors who are diligent will be able to find opportunities across industries and sectors. You need to have a stock-specific approach. Tilt your portfolio towards a couple of sectors that are trading at very low valuations.

Investors should not be overly concerned about volatility. Even 2017 saw volatility, except that it was on the upside. Now the volatility is on the downside. Once you tell yourself that cycles turn, you should not have too much to worry about. Use the downturn to buy quality companies and then wait for the cycle to turn. 

“Invest via SIP for at least five years”  -- S Naren, ED & CIO, ICICI Prudential AMC

S Naren of ICICI Prudential AMC

From 2016 to 2018, the broader market indices saw one of their sharpest rallies. Retail investors too embraced this space and most of the incremental investments in equities were made in mid- and small-cap funds, during this timeframe. However, there was one cause for concern – valuations. The valuation at which some of the mid- and small-cap names were trading seemed untenable. As a result, our fund house recommended investors to opt for large caps and dynamic asset allocation products over mid- and small-cap investments. Given the lofty valuations, our Portfolio Management Services (PMS) division returned investments in two of its small-cap PMS schemes in January 2018. Since then the BSE Mid-cap and the BSE Small-cap indices have lost 22 per cent and 32 per cent, respectively (data as on July 25, 2019).

Historically, mid- and small-cap names tend to trade at a discount to large caps. However, this was not the case during 2017. Midcaps were then trading at a large premium to large caps. In such situations, investors need to exercise caution. If they didn’t, there could be a notable impact on their investments. 

Currently, the midcap valuation is a tad above its long-term average. Going forward, we believe the growth in this space will be in line with earnings growth. However, one can expect volatility to prevail in this space owing to delayed earnings and expensive valuations. The aspect an investor has to remember is that while valuations have corrected, small and midcaps tend to deliver only after large caps. Furthermore, in a market cycle when large caps tend to deliver modest returns, small and mid-caps are unlikely to do well.

However, the outlook after the recent correction has become better. Investors with at least a five-year investment horizon can consider investing in mid- and small-cap schemes, but strictly through SIPs or STPs.