With small-cap stocks outperforming their large-cap counterparts by a big margin in the last three to five months (unlike 2022 where the former delivered close to zero returns), small-cap investors are like, ' Swagat nahi karoge humara ?' This year (as on July 31, 2023), the small-cap index had hit a return of 21.66 per cent followed by mid-caps at 18.75 per cent and Sensex delivering 10.34 per cent. Tread with caution Amid this segment making new highs, we studied the PE ratios of mid- and small-cap funds to find out how the valuations look like. The graph titled 'Weighted-average portfolio PE', shows the average PE of the category over the last five years. Though some distance from the peaks, PE ratios are hovering in the higher ranges in the context of the last five years. And fund managers do advise caution on valuations but they aren't overly worried. Shreyas Devalkar, Head Equity, Axis Mutual Fund, said, "With markets at all-time highs, valuations are mostly elevated, hence valuation risk does come into play here. Investors can consider this from a long-term perspective. In the past, the market has seen corrections and sideway movements after sharp rallies, however, sticking to good quality companies with growth potential has resulted in investors generating returns in the long term." Time to maintain composure The money ploughed into the mid- and small-cap categories suggests a kind of euphoria that has gripped investors. But it is highly advisable to stay away from such frenzy. In the last three months, the extravagant amounts of money being poured into these funds have raised the alarm, especially in small-cap funds amid rising index levels. We have always maintained that the mid- and small-cap space is only there to supplement your core equity portfolio. Aggressive investors should have about 20-25 per cent exposure to these funds. If the rally has exposed you too much to this segment, scale down your exposure. While the world is chasing these funds right now, you must stick to your plan and stay in good stead. Too big for boots? Questions have been raised on the growing asset size of mid- and small-cap funds. However, fund managers point out that while the asset kitty has risen, the increasing size needs to be seen in the context of market capitalisation. Pankaj Tibrewal, the fund manager of Kotak Emerging Equity Fund (one of the top five mid-cap funds by AUM and which has risen by over 110 per cent in the last two years), isn't overly concerned: "From the overall market free float basis, the holdings of the fund is 0.14 per cent of total free float market cap. The mid-cap holding commands 1 per cent of the listed mid-cap universe; likewise, small-cap commands 1.3 per cent." That said, another noteworthy point is that with the rise in mutual funds' AUM, the market structure has also expanded over the years (almost doubled in the last five years). Size of mid-cap stocks Year Median market cap Total market cap AUM of mid-cap funds AUM as % of total market cap Jun'18 15,577 24,76,945 67,038 3 Jun'23 27,862 44,73,611 2,22,122 5 All figures are in Rs Cr Size of small-cap stocks (Top 1,000) Year Median market cap Total market cap AUM of small-cap funds AUM as % of total market cap Jun'18 1,173 19,61,835 34,176 2 Jun'23 2,076 36,83,455 1,69,576 5
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