Creating Wealth with Small and Midcap Funds The growing interest in small and mid-cap is obvious from the fact that since the beginning of this year, these two categories have given impressive returns. While the Nifty 50 index has experienced a modest gain of around 10% in 2023, the small and mid-cap indices surged by an impressive 30% during the same period

In June this year, net inflows into smallcap equity mutual funds touched a record high of INR 5,472 crore, according to data published by the Association of Mutual Funds in India (AMFI). Since April this year, investors have poured in a whopping INR 22,551 crore in small-cap funds, followed by mid cap funds that witnessed INR 11081.59 crore. On the other hand, large cap funds which often dominate headlines and mainstream investor focus received only INR 5698.84 crore during that period.

The growing interest in small and mid-cap is obvious from the fact that since the beginning of this year, these two categories have given impressive returns. While the Nifty 50 index has experienced a modest gain of around 10% in 2023, the small and mid-cap indices surged by an impressive 30% during the same period. If one looks at the performance in the last six months, the Nifty Small Cap Index gained almost 33 per cent, while the Nifty 50 index of India's biggest listed companies is up just 15 per cent.

For the uninitiated, smallcap funds are those that invest in equity of companies with a market cap of around INR. 5,000 crore or less. Mid cap funds, on the other hand, are those, which invest in companies with a market capitalization between INR 5,000 crore and INR. 20,000 crores. Many mutual fund houses are bullish on the opportunity in this space, and have launched dedicated funds. Quantum Mutual Fund expects such funds to deliver better returns as the Indian economy grows. It has come up with its Small Cap Fund, an open-ended scheme which is benchmarked against S&P BSE 250 Small Cap Total Return Index (TRI). Similarly, Baroda BNP Paribahas also launched its small cap fund on the back of consistent outperformance of small cap stocks over large ones. It plans to adopt a sector agnostic approach for stock selection.

"There has been a growing enthusiasm for small and midcap stocks over the past few months. Industries such as Railways, Power, Electronic Manufacturing Services, PSU Financials, Real Estate have led this rally on the back of improved order visibility and demand trends," says Mahesh Patil, Chief Investment Officer (CIO), Aditya Birla Sun Life AMC.

Concurs Trideep Bhattacharya, CIO-Equities, Edelweiss MF, "We think that the broad-based upswing in equity markets over the last year or so can be attributed to the robust earnings performance of Indian companies across various sectors and marketcapitalisations. Consequently, this has led to an increase in the share prices of mid and small-cap companies."

SEVERAL ADVANTAGES

High growth potential

Smaller companies often have greater room for expansion as they operate in less saturated markets, and therefore have higher growth potential.

Undiscovered gems

Also small and mid-cap stocks often fly under the radar of mainstream investors and analysis, leading to potential mispricing and undervaluation. Many of today's large caps were once small and mid-caps .

Lesser institutional coverage

Since small and mid-cap funds stocks also have less institutional sell-side coverage, it allows mutual funds to make decisions based on their research and analysis, rather than being swayed by the market sentiment. Instead of companies with profits, one with free cash flows becomes the deciding factors.

WILL THE RALLY CONTINUE?

To the investor, the big question is: Will the rally continue? Adds Patil, "After the sharp run-up, we believe some stocks in the small cap universe have run up ahead of fundamentals and one needs to be cautious here. However, with the corporate earnings growth cycle looking positive, there are opportunities with favourable risk/reward for a discerning investor. We believe that investors coming at this juncture with a disciplined asset allocation would do well in the long term."

Bhattacharya advises discernment. "We maintain a positive outlook on mid and small-cap stocks for the medium term. Nonetheless, given the recent 40-60% surge in this segment over the past 3-6 months, we believe it's essential to exercise more discernment when selecting individual stocks within this category."

Resham Jain, VP, Investments, DSP Mutual Fund agrees with Patil and Bhattarcharya and says, " Market has already given handsome return YTD. Given the current valuation there is a possibility that market may remain range bound or could marginally correct as well. "

TAXATION

The tax treatment of gains made from this category of funds is simple. If redeemed after a year of purchase, long term capital gain tax (LTCG) kicks in, which is currently 10%. If redeemed a year before the purchase date, short term capital gain taxat 15% is applicable.

RIGHT ALLOCATION AMOUNT

So, what's the right allocation amount? "Allocation can vary depending on one's risk appetite. Investors who want to limit exposure and find pure mid and small cap funds risky, can always look at categories like flexi/large mid or multi-cap funds," says Girish Lathkar, Partner and Co-Founder, Upwisery Private Wealth.

"We endorse the idea that, in the current market conditions, it is prudent to maintain a well-balanced multi-cap portfolio that encompasses stocks from large, mid, and small-cap segments." shares Patil.

THINGS TO CONSIDER

Invest For longer duration

According to industry experts, investors should adopt a 5-10 year investment horizon when considering mid and small-cap stocks. "Additionally, it's important for investors to be ready for increased short-term volatility in these categories. Nevertheless, we believe that this period of heightened volatility should be viewed within the context of the potential for greater returns over the medium term," says Bhattacharya. Jain too advises investors with short-term horizon to refrain from investing in this category. "However, investors with long-term horizon (5-10 years) and with SIPs may continue to remain invested."

Be Vary of volatility

"Investors need to know that mid and small caps are volatile and can fall more than the benchmark indices, especially small cap funds. However, they also have the potential to deliver more than the benchmark returns if one is able to hold for a longer period of time," says Lathkar.

Professional guidance

Experts also advise seeking professional help to shortlist and invest in top quartile funds which have a proven track record.