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Size Does Matter

From the peak on May 10, the BSE Mid-cap index is down 28 per cent and the BSE

As We Move into August, the end of the great Indian bull run is old news. It is now almost three months since the BSE Sensex hit its peak of 12,612. Even though the markets are still in a very healthy state, not too many people are in a particularly happy frame of mind about the performance of their investments. The biggest reason for this sadness is that while the Sensex is indeed in a healthy state, most investors' portfolios are not. This apparent paradox is a direct result of our obsession with the Sensex. While the media generally takes the Sensex to be an indicator of the stock market as a whole, it is actually just an indicator of how well thirty large companies are doing.

Unfortunately, most individual investors, especially those who got attracted late into the stock markets have bought into much smaller companies than the kind that populate the BSE Sensex. And in general, the Indian stock markets have stayed true to the universal rule that the smaller a company, the more its share price falls when the markets go down.

At this point, the Sensex is down about 14 per cent from its peak. That's not bad, considering the fact that it went as low as 29 per cent below the peak at a time. However, we all know that many of us got a little too excited during April and May and bought into many small and medium-sized companies on the basis of rumours and dubious recommendations.

Unfortunately, this sort of investing has fared far worse than the Sensex. From its peak on May 10, the BSE Mid-cap index is down 28 per cent and the BSE Small-cap index is down 33 per cent. This is the equivalent of the Sensex being at 9080 points and 8450 points respectively. Can you imagine what the general investment climate would have been had the Sensex been at 8450 points today? Yet that is what the situation is for small companies.

This is quite a disaster. And in fact, the disaster is much greater than it appears at first sight. The index is just an average, and one weighted by the size of the companies. Therefore, the numbers you see for the Mid-cap and Small-cap indices are biased in favour of the larger companies among these. The smaller companies within these groups are far worse off. And even those are the companies that are at least worthy of being part the indices.

There are many investors who are still down to half the level that they were at in May. In fact, many do not know how much down they are because they are unable to sell some of their holdings which have turned illiquid.

But if we look at this situation and draw the conclusion that we simply needed to time the markets better or that we need to have access to better quality rumours than we would not have learnt the right lesson. The right takeaway from this is that small stocks are riskier than large stocks, and that it's just not possible for investors to time the markets consistently.

But the worse conclusion to draw from this could be to think that it's time to pack up and go home and come back again in the next bull run. The basic mantra of steadily investing in well-chosen stocks and funds that you understand is even more important now.

And if you are unable to avoid the temptation of the latest hot stock, don't worry, this happens to the all of us. Just make sure that your exposure to these is limited to whatever you can afford to actually risk to lose while in pursuit of windfall profits.