Mid- and small-caps continue to give positive returns despite sharp fall

If you have stayed invested for over a year, things are likely to be jittery till June-end when the mutual fund industry's reclassification exercise is completed

It has been turbulent times for mid- and small-cap stocks. With the Nifty Mid-cap 100 and Nifty Small-cap 100 slipping as much as 11 per cent and 16.1 per cent since the beginning of 2018, there is palpable fear among many investors about the prospects of their holdings in such stocks and mutual fund schemes.

These sharp falls have been for several reasons. For one, the valuations of many of these stocks have risen very sharply. For example, stocks like Indian Hotels, JSW Energy, Indiabulls Ventures and some others are trading at a price-to-earnings ratio (P/E) of over 100x (trailing 12 months) even after this fall. The Nifty Mid-cap 100 and Nifty Small-cap 100 is currently trading at the P/E of 52.7x and 67.3x, respectively. Interestingly, almost 30 per cent of mid-cap and 18 per cent stocks in their respective indices are still in the green.

Another reason is the market regulator, the Securities and Exchange Board of India’s (Sebi’s), reclassification norms for mutual fund schemes. The market regular had come out with the reclassification guidelines in October. However, the mutual fund industry has started repositioning itself only recently because the June 30 deadline for compliance is fast approaching. Under these guidelines, large-cap funds can have 80 per cent stocks in large-cap companies or top 100 companies. Mid-cap funds can have 65 per cent in mid-cap stocks, and multi-cap funds can have 65 per cent in equities. “A lot of repositioning has already happened. But there would be another round of sell-off in the next couple of weeks,” says the CEO of a mutual fund. 

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But what is interesting is that despite the sharp fall, both the mid- and small-cap indices continue to give positive returns over a one-year period. So, investors who entered these two segments over a year back are still not in the red. Over a one-year period, Nifty Mid-cap 100 and Nifty Small-cap 100 have returned 5.2 per cent and 2.9 per cent respectively. If one looks at the longer term, things will look much better for long-term investors even in these segments (See table). So it is not that investors have lost significant monies unless they were overexposed to specific stocks such as Vakrangee or Manpasand Beverages whose auditors resigned because of lack of information from the companies.   
 

In such circumstances, investment experts believe that it is a good time for most long-term investors in the mid-and small-cap stocks to book some profits. “If you are sitting on profits, it is a good time to raise some cash. But ones who are late entrants and sitting on losses, it makes sense to sit quiet,” says investment consultant Arun Kejriwal. However, while exiting remember that there will be a tax of 10 per cent on capital gains, but only if the gains are over Rs 100,000. 

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Other market experts also believe the same. “Unless the overall market scenario changes significantly, there is no reason for many of these stocks to keep on falling. So, investors need not worry too much,” says the CEO of a fund house. 

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For investors in mid-and small-cap mutual funds, the advice is obvious – don’t do anything. “Till the reclassification date goes, that is June 30, don’t buy or sell any mutual fund schemes. One does not know the extent of changes in schemes. So, till things are clear, it does not make sense to do anything,” adds the CEO. 
 

On the other hand, new investors with cash will have opportunities, feels Kejriwal. “These investors should identify their stocks and when there is a sharp fall, buy them,” he adds.  

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Investment experts believe that investors, typically, buy stocks or mutual funds after there has been a significant run up already. These latecomers into the party, somehow, believe that there is more steam in the rally and they will also make 50 per cent and 100 per cent returns in one year or less. But it seldom happens.

The best strategy, even while investing in riskier segments like mid-and small-cap stocks, is simply buy good stocks. And even if there are short-term hiccups, hold on. Otherwise, there is always the systematic investment plan route.