Fund Managers Sound Alarm on Mid and Small-Cap Overvaluation

Mumbai, India – 

The share of mid-cap and small-cap companies in India's total market value reached its highest level in May, driven by strong demand from domestic investors. However, fund managers are urging caution, citing concerns over excessive valuations.

Market Share Increase: According to ICICI Prudential Mutual Fund, mid and small-cap stocks accounted for 36.3% of India's market capitalization in May, up from 25% in December 2020 and 19.6% in December 2013.

Decline in Large-Cap Share: In contrast, large-cap stocks' share dropped to 63.7% in May, down from 74.2% in December 2020 and 80.3% in December 2013.

Performance Metrics: Over the past three years, mid and small-caps have outperformed large-caps. The Nifty Midcap 150 returned 57.46% and 28.05% over one and three years, while the Nifty Smallcap 250 returned 61.72% and 27.33%, respectively. Comparatively, the Nifty rose 26.34% and 15.82% over the same periods.

Valuation Concerns:

Excessive Valuations: Anish Tawakley, co-CIO equity at ICICI Prudential AMC, expressed concerns about the excessive valuations in the mid and small-cap segments, indicating that the current risk-return trade-off is unattractive.

PE Ratios: A study by Kotak Mutual Fund found the price-to-earnings (PE) ratios of Nifty Midcap 150 and Nifty Smallcap 250 are at a 29% and 27% premium to their historical averages, respectively. In comparison, the Nifty 50 is trading at a 4% premium.

Sector Contributions:

Sectoral Performance: The recent rally has been driven by outperformers in the public sector units (PSUs), defense, railway, and capital goods sectors, significantly boosting mid and small-cap valuations.

Investor Sentiment:

Continued Inflows: Despite high valuations, investor interest remains strong, with small-cap funds seeing inflows of ₹40,189 crore in 2023-24, up from ₹22,104 crore in 2022-23. Mid-cap funds attracted ₹22,226 crore, compared to ₹20,206 crore in the previous year.

Investment Strategy: Viral Bhatt, Founder of Money Mantra, advises investors to stagger their investments in mid and small-cap funds over a 7-10 year time frame due to the sharp run-up and rich valuations.

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