Mid & Small Caps: Bubble or Boom?

Is the mid- and small-cap rally a bubble or a sustainable rally? First and foremost, the honest answer is that I don't know. And assuming that I knew about it, I don't think we can really predict it. Whether it is in a bubble territory or not is entirely a function of a lot of investor behaviour. If the market starts going up again, it'll look as if it was not in bubble territory. If a lot of investors pull out money, it'll look like it was in bubble territory. We only get to know of it in hindsight - only after it has happened. The fact is that small- and mid-sized companies do better over time, but they carry substantial risks. That's because small companies can wither away in an economic down-cycle. They are small and cannot withstand very turbulent economic weather. So, small companies are generally vulnerable. Now, the point is, will you actually lose money? When you look at very long-term returns - 10-20 years - I find that, while small-cap companies are risky, the promise of smaller companies is that when they turn big, they are extremely rewarding. And that is the charm of small caps. Now, this is a very risky category. Let me just tell you the reasons. The number of small-cap companies listed in the Indian market is 4,586 as of today, which somewhat trade. Of this, 3,471 companies have traded every day or at least 90 per cent of the days in the past one year. This means that these are the number of active companies, and of these, mutual funds invest in only 609 companies. So, imagine a universe of 3,400 companies and mutual funds investing in only 609 companies. The remaining 2,800 companies - that is where you'll have many companies that will disappear. There will be many companies that do not exist, but they still trade. You might be buying the stock of a company that might be worthless. So, I think mutual funds really deliver a very high value in this segment. If you have to invest in large companies, then you have choices. You can invest in any of the bigger companies yourself. Dropping a few companies from the top 50 companies of the Nifty, which may have a bleak outlook, is relatively easier. But here, of the 3,400 companies, the mutual funds have narrowed the universe to 600 compani

This article was originally published on February 21, 2025.