Time to be watchful

2023 was a blockbuster year for the mid- and small-cap indices. In the second half alone, they gunned out returns of 27 and 30.3 per cent, respectively, compared to the Sensex's modest 14 per cent. However, 2024 has started on a much sombre note, with the duo witnessing intermittent falls. How's the josh? High sir! Investors collectively pumped Rs 64,000 crore into mid- and small-cap funds in 2023, accounting for 40 per cent of the total flows garnered by all equity funds. It appears that investors are drawn by the allure of the rocketing rally and the impressive performance numbers. But it's important not to underestimate the risks involved. While mid- and small-cap funds can provide incredible returns, they are prone to sharp declines. For instance, in 2008, small-cap funds fell by over 57 per cent, leading to significant losses for investors. In the following year, these funds had delivered a 94 per cent return. This aptly sums up the roller-coaster nature of small-cap investing. Assessing small-cap funds' portfolio Usually, rising flows into mid- and small-cap funds force fund managers to dilute the focus by getting into slightly larger-cap stocks or go down the quality curve. This is not a comfortable situation to be in. So, using our Value Research Stock Ratings, we decided to analyse the current quality, growth potential and valuations of small-cap fund holdings in the last one year. The findings revealed that the quality of small-c

This article was originally published on March 15, 2024.