Wealth managers advise clients to reduce their exposure to smallcaps

Somnath Mukherjee of ASK Private Wealth says the risk in the smallcap space has more to do with the enhanced regulatory scrutiny and the slowdown in profit growth

The froth in the small and midcap (SMID) space is limited to a few pockets, but regulatory scrutiny could lead to sustained volatility, observe India’s top-drawer wealth managers. They add that they have been advising clients to reduce their exposure to smallcaps.

Anand Rathi Wealth, which manages investor wealth through mutual funds (MFs), reports that its exposure to smallcap stocks, both through MFs and directly, has decreased by nearly 7 percentage points in the past few months, now standing at 23 per cent.

 

Motilal Oswal Wealth says that most of its clients have reduced their smallcap allocations.

According to ASK Private Wealth, their client portfolios have seen a shift towards largecaps.

“We have made huge profits, thanks to the year-long rally in the SMID space by allocating close to 50 per cent of our model portfolio into these segments. Now, we are reducing our exposure. However, we will maintain a substantial allocation to SMIDs as valuations have not yet reached excessive levels at an index level, and companies are expected to deliver strong earnings growth,” says Feroze Azeez, deputy chief executive officer at Anand Rathi Wealth.

Somnath Mukherjee, chief investment officer and senior managing partner-product and research at ASK Private Wealth, says the risk in the smallcap space is more related to enhanced regulatory scrutiny and slowdown in profit growth.

“Broad SMID valuations are close to those of largecaps. A bigger factor to note is underlying business performance, where top-line growth has started to slow down, and bottom-line growth is also decelerating. However, this isn’t limited to the SMID space alone. The biggest factor to be mindful of is enhanced regulatory scrutiny on SMID-listed space. This can lead to a prolonged period of increased volatility, and investors need to be prepared for it,” he says.

The 12-month trailing price-to-earnings (P/E) ratio of the National Stock Exchange Nifty Smallcap 100, which surged to a high of 28x in February, has now decreased to 25x after an 11 per cent correction. The largecap Nifty 50 is trading at a P/E ratio of 22.8x.

 

In a report, Kotak Institutional Equities noted that the sharp run-up in SMID indices in the past six months was largely led by lower-quality and narrative stocks. The report shows that despite the strong index-level run-up, many sectors within the SMID indices, like specialty chemicals, media, and internet software and services, have generated negative returns.

Sandeep Raina, executive vice-president-research, Nuvama Professional Clients Group, says the recent correction has provided investors with an opportunity to add good quality stocks to their portfolios.

“This is the right time to invest in quality stocks. Some companies have fallen 20-30 per cent without any change in their business fundamentals and growth expectations,” he adds.

Senior executives at other wealth management firms agree but expect better buying opportunities to emerge.

“The recent correction has slightly improved valuations. However, it has been observed that momentum, both on the upside and downside, can continue for a long time before a sudden reversal. Also, the correction hasn’t been that meaningful yet. Hence, we don’t consider it an opportunity to jump in,” says Alekh Yadav, head of investment products, Sanctum Wealth.

“This correction is purely technical, and India’s equity market fundamentals continue to remain healthy. General market sentiment should remain buoyant with continued expectations of political stability. Valuations may take some time to correct in this scenario, and one can continue to allocate funds on every dip while considering their overall asset allocation and market capitalisation weight within equity,” says Jayesh Faria, director, regional head-west, Motilal Oswal Private Wealth.