Tipping point: Should investors take a contra bet on small-cap funds now?

Small-cap funds have been among the worst-performing categories of equity funds over the past year, with a category average return of -11.63 per cent. A primary reason is that this segment had been outperforming since 2013-14, and then began to consolidate from the start of 2018. Valuations for small-cap indices had reached exorbitant levels of more than 100 at the peak of the rally. 

The correction of the past year has brought greater sanity to valuations. The Nifty Smallcap 100 is now trading at a price-to-earnings ratio of 30.40. This is quite close to the current Nifty P/E of 29.13.

The long-term returns of this category — 10-year return is a mouth-watering 19 per cent compounded annually — create a strong case for investing in it. However, exposure to these funds should not exceed 10-15 per cent of the equity portfolio and the investment horizon should be at least seven years.