Mid, small cap funds offer double-digit returns; is the recovery here?

Small and mid cap funds have outperformed all other equity mutual fund categories in the one-year horizon. With 22% and 18% annual returns respectively, both these risky equity mutual fund categories are enjoying their spot under the sun. The topper in the small cap category has offered a whopping 60% return in one year. On the other, the topper in the mid cap category has offered 44% returns in one year. Looks like small and mid cap funds are back in action. Are they?

The S&P BSE Small Cap Index has offered 25.46% returns in one year, and S&P BSE Mid Cap Index 13.18% in one year. Here’s a look at the top performers of both the categories:



Source: Value Research

Fund managers agree that both mid and small cap segments recovered a bit, but they warn that these segments might not see a broad rally from in the coming days.

“We think there is value in small and mid cap space. Valuations are not cheap, but reasonable. In the mid cap segment, many companies have done well. However, small and mid cap investing is going to be more selective now. The entire basket of stocks is not likely to go up from here. Now it will be more driven by the merit of the businesses. Having said that, we also believe that there are enough opportunities available in both small and mid cap segments,” says Neelesh Surana, CIO-equities, Mirae Asset India.

Fund managers believe that nothing has dramatically changed or moved in favour of small cap funds lately. They believe that this is a cyclical rally. “How I see this is that the small and mid cap segments fell after March and they are recovering now. It is cyclical,” says Surana.

Another senior fund manager with a private sector mutual fund believes that the recovery hasn’t happened fully. “Small and mid cap schemes have seen sharp underpermance in the last 3-4 years. The valuations are still reasonable if not cheap. The market is more excited about the cyclical rally in the small and mid caps. Our view is that it is too early to call this a recovery. The small and mid cap segments have some good picks but not a good time for blanket buys,” he says.

Surana says that a lot of consolidation is taking place in favour of stronger franchises which are generally large companies. Small caps are reasonably valued in the market, but there are stocks in the small and mid cap segment also which are expensive.

“Quality of mid cap stocks are strong. There is liquidity risk in small caps. Investors should be aware of the volatility involved in these segments, especially small cap funds. I would suggest not overdoing small and mid cap investments for chasing returns. The risk reward is still in favour of multi and large cap funds” says Surana.

These fund managers believe that this rally is not like the one we saw in 2016-17. There is no froth in the market. There are expensive stocks in certain segments of the market, but P/Es are still reasonable. They ask investors to be cautious and not go overboard on small and midcap investing.

“Investors should invest in small and mid cap schemes if they have the risk appetite. You should know that liquidity is an issue in these segments. Investors should try to invest in a staggered manner to minimise risk. However, it is not a bad starting point if one wants to start investments in small and mid cap schemes. Valuations are still attractive. In a 5-years plus horizon, the risk-reward gets better,” says the fund manager who doesn't want to be named.