In May, total inflows into small cap funds stood at Rs 3,282.5 crore. Point to note: Investment in small-cap mutual funds is associated with higher risk lcompared to large and mid-cap funds as they invest in lesser-known and under-researched companies.
“People are withdrawing money from large cap funds and trying to put it back in the small cap fund because they find that there is a potential to make more gains in the small cap funds,” said N S Venkatesh, Chief Executive Officer (CEO), AMFI.
Overall, the combination of strong performance in small-cap stocks, the desire to participate in the market rally, and the resultant preference for mid and small-cap funds contributed to the massive surge in small-cap funds in India in June.
Valuation gap between small and large companies is high
“Since the last few months small-cap stocks have shown a tremendous outperformance. The major reason for this could be the valuation gap between small-cap companies and large-cap companies. This always happens when markets become a little expensive but the fund flow chases stocks. In such type of market, fund managers try to find out values or pockets of opportunities on a comparable basis that are available at the lower end of the radar. These stocks are with a low base and can grow at a higher pace compared to large companies in terms of percentage growth and are undiscovered stories. Hence higher risk equals higher reward. The massive fund flow via mutual funds, PMS or direct equity investors has added more momentum to it. If you see the performance of small-cap funds in the mutual fund space, the 5-year CAGR is around 18-21 per cent ,3 years at 40-45 per cent and 1 year at 30-37 per cent,” said Mukesh Kochar, National Head-Wealth, AUM Capital Market.
In the last six to 12 months, small cap equity funds have given a return of around 12-15 per cent on an absolute basis. When a fund outperforms, money is bound to chase it.Also Read: Bull Run: 5 smallcaps hit new 52-week highs; charts show up to 19% upside
There has been a substantial rise in small-cap stock prices, with the Nifty Small cap 100 index gaining close to 15% returns in 2023, which is double of the benchmark indices Nifty 50 during the same period. This performance attracted investors to the small-cap category.
“Investors have been favouring mutual fund schemes that invest in the broader end of the market, including mid and small-cap funds, as there is also an underlying expectation that such broad-ends offer fund managers the opportunity to discover meaningful number of alpha generation opportunities. Most investors are seeking to participate in the rally and take advantage of the potential for high returns,” said Nirav Karkera, Head of Research, Fisdom.
Rs 17,869 crore poured into small cap funds in last six months
In the past six months of the year, investors poured approximately Rs 17,869 crore into small-cap schemes .Small cap funds received significant inflows, accounting for 27% of the total inflows till June 2023.
“This preference for small-cap funds reflects investors’ confidence in the potential growth of smaller companies and their willingness to take on higher risk for potentially higher rewards,” said Karera.
Data analysed by ICICI Securities shows that the small-cap index has jumped 24 per cent since the end of March 2023. In the same period, the mid-cap index has gone up 22 per cent; the large-cap-focused National Stock Exchange Nifty50 Index has risen 14 per cent.
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Small-cap funds have witnessed substantial growth in asset size over the years. From May 2020 to May 2023, the assets under management ( AUM) of small-cap funds in India surged from Rs 38,820 crore to Rs 1.54 trillion. In the last three years, Quant Small Cap Fund, Nippon India Small Cap Fund, Canara Robeco Small Cap Fund, HDFC Small Cap Fund, and Tata Small Cap Fund have been among the five top-performing Small Cap Funds. Seeing the double digit returns, investors have been deploying their investible surplus into small cap funds, particularly in 2023.
Venkatesh said investors are putting money in small-cap after being fully aware of the risk involved and many of them would have booked profit from large cap and focused funds to invest in small-cap funds for higher returns as small-cap index have crashed 60 per cent.
Case-in-point: Small-cap fund performance
Source: ACEMF, Fisdom Research Data
The problem of plenty
But this rush for small-cap funds have put fund managers in a tight spot and given rise to problem of plenty. In July, two fund houses — Tata MF and Nippon India MF — stopped taking lump sum inflows into their small-cap schemes, citing deployment challenges amid rising small-cap valuations.
Earlier, towards the end of June 2023, Tata Mutual Fund also temporarily stopped fresh inflows into Tata Small Cap Fund. HDFC Mutual Fund, which launched its new fund, HDFC Defence Fund in May 2023, a month later announced that it is temporarily discontinuing lumpsum investment and restricted SIP transactions. Even SBI Mutual Fund has suspended lumpsum investments in its SBI Small Cap Fund since September 2020 and is currently accepting SIP investments up to Rs 25,000.