Investors in mid cap and small cap funds have suffered significant losses during the last two years. Their broader indices which saw a marathon rally for nearly five years till January 2018 and hit their all-time highs have hugely underperformed when compared to their larger counterparts.
While Sensex and Nifty have gained 19% and 12.20% in two years, BSE small cap and midcap indices have lost 24.70% and 13.70% during the same period. On the other hand, BSE large cap index has gained 10.20% during the last two years.
BSE small cap and mid cap indices are down nearly 58% and 24.82% from their all-time highs of 20,183 and 18,321 reached in January last year.
The market looks nervous and has entered volatile zone, mainly due to a more than expected correction in small cap and midcap indices.
With nearly two years of constant losses, investors face a dilemma of whether to stay invested in funds of small cap and mid cap indices or switch to large cap or multi cap funds to erase losses.
VK Vijayakumar, Chief Investment Strategist at Geojit said, "Markets, particularly segments like mid and small caps, tend to over-react. Over-reaction happens both on the upside and downside. The mania for mid and small caps in 2017 was irrational exuberance. That bubble has burst. Now, valuations have become attractive. That doesn't mean that investors should substantially increase allocation to Mid and small caps. They can increase allocation through SIPs. Investing in multi-caps would be a good investment strategy now since the fund managers have the flexibility to move out of expensively priced large caps to attractively priced mid and small-caps."
A host of factors such as overvaluation of stocks and lower than expected earnings of firms in the midcap and small cap segment has led to a fall in the broader indices.
Jayesh Faria, senior executive group vice president at Motilal Oswal Private Wealth management said, "Rebound will surely happen but one doesn't know when, whether it will happen in two quarters or four or will it get worse than this is anyone's guess. Investors should go back to their asset allocation and within their investment charter. If that is in line with their risk profile and time horizon, then one should stay invested."
Corporate governance issues, mutual fund portfolio rejig and the ongoing slowdown in the economy have also weighed on sentiments surrounding the mid cap and small cap stocks.
Umesh Mehta, Head of Research at Samco Securities said, "We have witnessed times where historically both small and mid-caps have outperformed as well as underperformed frontline stocks during bull and bear phases of the market. Of course, barring the large cap stocks, correction has been overdone by the market in small and mid-cap stocks for past 7 to 8 quarters.
The present underperformance seems to be exceptionally overdone and we can say with a high probability that mean reversion will play out and alpha would be generated by staying put with small and mid-cap stocks. Hence, one should not switch boats in the middle of turmoil but ride the small and mid-cap wave which is about to take a virtuous turn. However, they can still make fresh allocation to large cap stocks."
According to market analysts, smaller stocks are generally bought by local investors, while overseas investors focus on blue-chips. Mid-cap index tracks companies with a market value that is, on an average, one-fifth of blue-chips or large firms. Small-cap firms are almost a tenth of that.
Analysts advise investors to include large cap, mid cap and small cap stocks in their portfolio to hedge against losses in the volatile market.
Ajit Mishra, Vice President, Research at Religare Broking said, "Equity as an asset class has been volatile in some years but it has also yielded strongest returns if invested for longer-term horizon. However, in such trying times, the ideal strategy would be to construct a portfolio based on risk appetite of investors which has combination of large cap, midcap and small cap stocks and invest in a staggered manner (SIP)."
Sachin Shah, Fund Manager at Emkay Investment Managers said, "The small cap index is down by nearly 35% in last 18-20 months. The price-value gap is now significant in quite a few quality mid and small cap stocks and therefore, it is just a matter of time (may be less than couple of more quarters) that the price of high-quality mid- and small-cap stocks start reflecting their true value and potential. If the investors have done their asset allocations in line with their profile, they shouldn't tinker too much with the allocations with the overall sentiments in the markets."
On reallocating portfolios, Shah said, "If one is light on small caps , this is not a bad time to allocate some allocations to some small-cap MFs / PMS / AIF."
Mid cap stocks typically have market capitalisation between Rs 5,000 crore to Rs 20,000 crore. They are much smaller than large cap firms which enjoy market capitalisation of above Rs 20,000 crore. Small cap firms are either start ups or companies in the development stage. They have low revenues and a small number of clients and employees.