Explained: Risks to assess before investing in small and mid caps

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Over the past three months, while the benchmarks – Sensex at BSE and Nifty at NSE – have not been significantly affected by the second wave of Covid-19, the mid-cap and small-cap indices have seen a strong recovery. Against a 6.4% growth in the Sensex since April 1, 2021, the BSE mid cap and small cap indices rose by more than 10% and 20% respectively. Amid valuation concerns in this space, experts say investors should be careful entering fundamentally weak, small and mid-cap companies, and should instead invest through mutual funds that have the flexibility to invest in large, medium and small caps.

How much have the mid and small cap indices increased?

The BSE mid and small cap indices have outperformed the Sensex not only in the past one year and three months, but even in the short term of the past three weeks. Since June 1, against an increase in the Sensex of 1.5%, the mid and small cap indices have increased by 2.6% and 5.5% respectively.

It is often seen that when the market witnesses a big rally, mid and small caps increase much more because they see a significant revaluation of stocks in these categories, and large and individuals invest in them.

However, as the momentum in the small and mid-cap segment has led to a rally even in stocks of companies with weak fundamentals, experts say retail investors should be cautious and not be lured by the high returns that some stocks (along with weak corporate fundamentals) may have generated over the past two months.

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What is the risk for investors?

Although there are a number of good companies in this segment with strong business fundamentals, investors should be careful about the amount of their exposure as it can drop sharply in times of market correction.

“The rise in mid and small caps is due to excess liquidity in the market and the large investors who invest in it. However, when they exit, these companies (although they may be good) may fall faster than they have risen because liquidity is low in many of these stocks, ”said CJ George, MD, Geojit Financial Services.

While mid and small caps have outperformed Sensex and Nifty over the past year, market participants say their recent rally is also driven by an increase in retail investor participation, and that’s another reason for concern as many of these investors have increased their exposure to mid and small caps.

While investors need to be careful at the aggregate level, some believe there are pockets of opportunity in sectors still under Covid-related stress, such as hospitality and multiplexes.

Experts believe that investors should limit their exposure to small companies. Stating that there are exciting opportunities in small caps, S Naren, CIO, ICICI Prudential AMC warned that investors should look to flexi-cap funds. “In a period of synchronized global market correction, small caps tend to undergo aggressive corrections… We believe that flexi-cap is an interesting category because it allows the corpus to be deployed on large, mid and small caps based on the relative attractiveness of these individual pockets. In addition, it is a category among equity regimes that is the most flexible, ”Naren said.

Why are flexi-cap funds considered a good bet?

While multi-cap funds were previously free to invest in small, medium and large-cap companies, the SEBI regulator has limited these programs to mandatory investing a minimum of 25% each in these segments. But flexi-cap funds do not have such a cap and fund managers benefit from the ability to increase or decrease exposure to a small, mid and large cap equity depending on the market outlook. SEBI created flexi-cap as a new category last year.

While investors with large funds can split their investment between large, mid and small cap funds, retail investors with limited funds to deploy but looking to take advantage of business growth can look to flex funds. cap. Some believe that since the fund manager has the flexibility to transfer funds from one to another, he can actively manage based on emerging growth opportunities or risk perceptions.

What are the risks for market growth?

As the risk of a new wave of Covid persists and concerns grow around inflation, market participants also believe that a good monsoon will strengthen rural India and demand an economic recovery. When it comes to inflation, many believe this may not be a factor to be feared as long as central banks remain pro-growth. It is only if central banks become hawkish and take steps to drastically reduce their purchasing program that the impact could be negative. At this point, there could be a significant correction in asset prices and the economy.


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