Mutual fund investors show bias towards riskier small-cap-oriented schemes

In March, inflows into small-caps highest among market cap-oriented fund categories

Notwithstanding sharp volatility in March, mutual fund (MF) investors didn’t fight shy of investing in riskier small-cap-oriented schemes. Inflows into small-cap funds were not just the highest in absolute terms, they were also the maximum as a proportion of assets under management (AUM) among all market capitalisation (m-cap)-oriented categories.

Investors funnelled Rs 2,430 crore down small-cap funds — 1.8 per cent of their AUM of Rs 1.33 trillion. Meanwhile, inflows into mid-cap schemes were 1.2 per cent of their AUM, while those into large-cap schemes were just 0.4 per cent of AUM.

“Active m-cap-based MF portfolios saw a much higher degree of buying by mid- and small-cap funds, compared to large-cap funds. This indicates a propensity to add ‘size risk’ by domestic investors,” wrote equity strategists Vinod Karki and Niraj Karnani of ICICI Securities in a note.

Net investments in small-cap schemes in 2022-23 (FY23) were more than double those of large-cap funds. Data from the Association of Mutual Funds in India shows investors in FY23 channelled a net Rs 22,100 crore into small-cap schemes, compared with just Rs 8,370 crore into large-caps.

Mid-cap schemes received Rs 20,200 crore. The inflows have also been consistent throughout the year, with investors pumping in over Rs 3,000 crore into small- and mid-cap schemes in 10 of the 12 months.

While the entire market has come off its highs, the small-cap universe has seen maximum correction.

The Nifty Smallcap 100 is currently 22 per cent below its all-time high of 12,047 logged in January last year. By comparison, the Nifty50 is less than 7 per cent shy of its high of 18,888 hit on December 1, 2022. The Nifty Midcap is less than 5 per cent away from its record high registered in October 2021.

Investing in the small- and mid-cap space is considered riskier, compared to large-caps, as the former tends to be more volatile. However, investing in mid- and small-cap MF schemes is comparatively safer.

“Aggregate mid- and small-cap MF portfolios are relatively expensive and have a higher return on equity (translating into growth stocks), compared to benchmark indices (Nifty Midcap 100 and Nifty Smallcap). Overall, the factor weights of mid- and small-caps funds, compared to the benchmark indices, indicate relatively less risky portfolio…thereby implying a relatively defensive stance,” reads a note by ICICI Securities.

Analysts feel the strong inflows into riskier schemes are tantamount to investors betting for the long term.

“Despite the volatility of broader equities throughout March, investors actively took advantage of more focused plays offered by sectoral and thematic funds. These investors recognise the long-term growth potential and are willing to capitalise on buying opportunities during market corrections. This trend is also reflected in the net inflows seen in mid- and small-cap categories,” says Anand Dalmia, co-founder and chief business officer, Fisdom — an MF distribution platform.

The other reason behind the surge in inflows into small- and mid-cap schemes is the belief that fund managers have the highest room for alpha generation in these pockets. Lately, reports have shown that the most actively managed large-cap schemes have failed to beat their benchmarks across time frames. As a result, investors have started to prefer passive schemes for their large-cap allocation.

On the other hand, a majority of small-cap schemes have fared better vis-à-vis their benchmark. Value Research data shows that the average returns of all small-cap schemes have typically been more than the benchmark S&P BSE 250 SmallCap Total Returns Index in the past 10 years. Three of the top five schemes in the 10-year returns chart are small-cap schemes with over 26 per cent annualised returns.