Since the start of 2018, the bears have taken control of the small-cap and the mid-cap segment of the Indian capital market. The benchmark indices S&P BSE Small-cap corrected as much as 23.5% in 2018 after a sharp run-up in 2017.

Despite the slide, mutual fund houses seem to have faith in the segment and are continuing to place bets in the segment or launching new schemes in the segment or re-opening the previously closed funds for a fresh subscription.

Be it mutual fund managers, fund advisors or market experts – everyone is busy predicting a revival in the small-cap and the mid-cap space.

While some see value gain after the steep fall in 2018, others believe it is the right time to invest in the space given the economy is going for election and re-election of current government could only do wonders for the segment.

But, is this the right time to buy in the small-cap and mid-cap segment?

Let’s find out the answer to the pressing question every investor might have in his or her mind before investing.

Back in the comfort zone?

The small-cap space corrected 23.5% in 2018 but saw a trend reversal in 2019 with the index gaining nearly 2% in the first quarter of 2019.

Does this indicate that the segment is back in the comfort zone of investors?

Let’s Find Out

We believe the sharp correction in the segment has thrown up exciting opportunities and cooling valuation has tilted the risk-reward scale in favor of some fundamentally strong stock.

Of the 500-stocks basket, as much as 50% has lost more than 30% value, and nearly 15% has lost over 50% value.

If you have to see the valuation premium, the premium for the index overall has reduced from nearly 70% a year ago to merely 15% currently. This narrowing of premium indicates higher rewards in the small cap space.

The correction has been steep enough thereby making quality small cap names more accessible. Fund managers, now, have the opportunity and flexibility to deploy the surplus funds in the territory without having to dig deeper.

This is a result of both – the correction in the small-cap segment and also due to the rule introduced by the market regulator (SEBI) with regards to the definition of market capitalization.

The rule that defines the investible universe of stocks for different fund categories has prodded fund houses to reopen subscriptions. As per the new regulations, a small-cap fund can now pick stocks that rank beyond the top 250 names.

This has widened the hunting ground for small cap funds, and fund managers can now create a more hygienic portfolio without compromising on the quality of the stocks in the basket.

Funds like SBI Small Cap Fund have implemented a strong allocation strategy, which has strengthened the fundamentals of the schemes.  

The Long-Term Profile Remains Healthy

The small-cap segment has rewarded investors over the long horizon. But an investor should stay cautious before investing and should not jump into this segment simply because the funds have started accepting money again.

The correction in the space along with the reopening of the funds for subscription has opened up investment opportunity, but an investor should be mindful of their asset allocation.

What Should the Approach be?

While reviewing your portfolio, if you find your portfolio to be light in the segment, you may put to use the correction as an opportunity to shore up your presence in the area.

Remember, the small-cap segment is prone to high volatility, thus the sharp correction provides an ideal opportunity to invest as the risk-return profile is favorable.

But, as an investor, you should only invest via the Systematic Investment Plan (SIP) route. This helps you fetch a higher number of units and comparatively lower prices due to the disciplined approach to investing. SIPs help normalize volatility and deliver healthy returns over time.

For investors who have started a SIP in the small-cap fund in the past 12-18 months, you should hold on to your investment irrespective of the mounting losses currently. The segment has proven to be highly rewarding for those who continued investing regularly over the long-term.

Remember, the money that is not invested is not growing and investing from now until when the markets start growing up will average the cost of acquisition and help in the long run.

We expect the small-cap funds to start performing again in the next couple of quarters. Though the segment is not likely to return to the performance level of 2017, it is undoubtedly going to see a run-up post the election outcome provided the outcome is favorable for the investors.

What Does Macro Say?

India’s macro outlook is currently one of the best among emerging economies and is much better than at any time in the past decade.

India is a classic example of an economy with many idiosyncratic domestic factors that are less impacted by the global headwinds.

The economy has the potential to grow at 7-8% real rate for the next decade with a normally functioning government. India Inc. has done a great job in delivering the earnings growth that is in line with the normal GDP growth owing to the entrepreneurial nature.

Lastly, India is going to see over 200 million people entering the earnings bracket, thus throwing up a tremendous opportunity for the growth of consumption driven sector

We believe the Indian market should compound at a similar rate going forward and compounding of this outperformance over time shall have a significant bearing on the portfolio’s performance.

Thus, an active investor, in an alpha-rich market such as India, could not only outperform the benchmark but generate several times more returns as compared to the developed economies such as the US despite a weaker asset class.

Thus, an investor has all the reasons to remain excited while investing in one of the youngest and fastest growing economies of the world.

To conclude we can say that an investor should remain invested and adopt a disciplined way of investing. Also, small-cap funds are must-to-have in one’s portfolio if you are looking for wealth creation.

And, yes it is the time now, time to invest in the small-cap segment and grow your wealth.

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