Banking Article, Banking Finance 2020, Banking Finance March 2020

Small caps for long term

Mid and small caps are in serious trouble since the latter half of FY18 and the first half of this financial year is no different. In fact, at the first look, the slump does not seem high but the individual small and mid cap stocks are touching historic lows almost every other day. Investors are in for rude shock as damage to some of these stocks was more than 40 per cent. This has lead to around 30 per cent erosion in small cap value damaging sentiments.

However, with a positive Budget that was proposed by the Finance Minister, there has been a turnaround. With the coming up of FPI inflows and effect of pre-election rally in setting the indices is pointing towards the emergence of low value buying in some mid and small caps. A strong rebound is being witnessed and this is indicating the testing of resistance zones. Convergence of descending cap value and high indices is most likely to display more spirit and further rise could mean forward movement in index riding on increased buying interest.

Same is the case with mid cap where a renewed enthusiasm can be seen, which is helping the indices move ahead. Despite being on the decline, midcap has been showing some signs of optimism. It can be said that a breakout is sometimes necessary for upward traction.

For the investors, it is important to understand the reasons behind this mayhem. First, mutual fund re-categorisation by SEBI as the new rules for mutual funds lead to the bubble burst. Mutual funds had to group their equity schemes based on market cap of the stocks the scheme has invested in. This led the active funds to trim their portfolio weights in such stocks. Second factor was the concerns regarding corporate governance in individual stocks. Bad governance of a handful few stocks destroyed the market and a majority of stocks in this category. Mid cap and small cap category were the worst hit as investors sold off their holdings in these stocks. Third, Additional Surveillance Measures (ASM) was introduced to safeguard investors but liquidity in stocks under ASM plunged.

In the current scenario, it would be safe to say that the retail participation is getting initiated and the time is right for investing. Things are improving as FII money is coming back, the uncertainty due to elections is eroding, and market is coming back to life. One should also understand that small companies rebound faster than the larger companies in growing economy. Policy decisions are implemented faster in these companies as they have less layers of management as against the larger companies. Historically, small cap also respond quickly to positive environment and grow faster than large-cap stocks.

Another factor is that the small companies as well as the growth-oriented stocks raise capital from investors by selling shares of stock whereas larger companies issue bonds. The negative impact of high interest rates is less on the growth of small companies as these companies do not rely on bonds to expand.

In conclusion, the investors should stick to the tried and tested basic of buying more shares of small-cap during bear markets and keeping a balanced portfolio of asset allocation. It should also be known that sharp corrections gives an opportunity to invest as the risk-return profile is more in the favour of investor. Keep in mind that Small and mid-cap have always come out as highly rewarding over the long term.

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