Mutual funds raise bets on mid & small-cap stocks amid volatile markets

• In the last three quarters, while the smallcap funds saw net inflows of ₹15,172 crore and midcap funds had inflows of ₹14,632 crore, large-cap funds witnessed inflows worth less than half of the two at ₹6,392 crore.
• AMFI data shows that since October 2021, smallcap schemes witnessed continuous inflows hovering around ₹1,600 crore.
• In January 2023, inflows into smallcaps was at a multi-month high of ₹2,300 crore and that too without any new fund offers (NFOs).
• Analysts say that midcap and small-cap indices have been doing well post Covid lows.

In the last few months, mutual funds have been favouring mid and small-cap stocks. Prominent among such stocks that saw buying were Delhivery, Policybazaar and Zee Entertainment, shows data by Prime Database.

Interest in mid and small caps has been growing in the last three quarters – while smallcap funds saw net inflows of ₹15,172 crore, midcap funds had inflows of ₹14,632 crore. Large-cap funds witnessed inflows worth less than half of the two — at ₹6,392 crore in the last three quarters.

Data from Association of Mutual Funds in India (AMFI) shows that since October 2021, smallcap schemes witnessed continuous mutual fund inflows of around ₹1,600 crore. In January 2023, the inflows into smallcaps was at a multi-month high of ₹2,300 crore – and that too without any new fund offers (NFOs).

In volatile market conditions witnessed in the last few months, investors are betting on mid and small caps. "These are typically retail investors that allocate excess funds into these categories of funds because they feel return potential is higher in these categories with relatively lower risk than investing into stocks directly, as the fund manager takes decisions and because of diversification benefit," said Pranav Haldea, managing director at Prime Database Group.

Better returns, high-growth sectors
Analysts say that midcap and small-cap indices have been doing well post the lows hit during Covid times. They delivered better returns than the top 100 companies and that’s what has been driving inflows into these sectors.

“Investors often look at past returns and decide where to invest. Whether this is right or not is a separate topic. At the end of February, mid and small-cap funds have delivered better returns in 1, 2, 3 years (Nifty Midcap 150 delivered 8%, 15% and 23% respectively vs. 2%, 9% and 16% by NIFTY 100). We believe this is the primary reason for investors rushing to these categories,” said Srinivas Rao Ravuri, CIO-Equities at PGIM India Mutual Fund.

In terms of valuation, midcap valuations are at par with that of large caps now, while small caps are trading at a discount to large caps. Dikshit Mittal, fund manager & senior equity research analyst at LIC Mutual Fund said that the small-cap index is down 23% from its all-time high, while the midcap and large-cap indices are down 8% and 10% respectively.

Ravuri says that while large-sized companies are likely to report moderate growth rates, mid and small companies that are in a relatively early stage and investing in newer businesses or niche segments can deliver faster growth.

Moreoso, mid and small caps represent a lot of high-growth sectors be it QSR (quick-service restaurants), retail or even logistics.

“Also, many emerging and high-growth sectors like QSR, retail, logistics, building material, chemicals etc are having representation mainly in midcap and smallcap indices, which makes it imperative for investors (with high-risk appetite) to look at smaller indices to take exposure to high-growth sectors,” said Mittal.

Pizza Hut franchisee Sapphire Foods, which is a QSR, saw the second-highest buying by mutual funds among small caps in the December quarter. The most buying was seen in Sheela Foam that sells mattresses under the brand Sleepwell. Reports say that the company is looking to expand into newer business categories and may acquire furniture rental startup Furlenco.

A recent report by Jefferies also suggests that some consumer mid-cap companies may benefit from a good summer. The India Meteorological Department (IMD) has forecast a strong summer, with 'above normal' temperature in many parts of India. Key sectors benefiting from a good summer are fans, ACs, refrigerators, pipes (agri), air coolers and pumps, shared the report.

“We foresee Crompton (leader in fans and residential pumps), Havells India (Lloyd AC), V- Guard (stabilisers, fans), Amber Enterprises India (AC volumes), Finolex Industries (agri-pipes leader) and Supreme Industries (diversified mix) as key beneficiaries. In Q4FY23, we expect (on) average over 14% year-on-year sales growth and over 110 basis points quarter-on-quarter operating profit margin rise for these companies,” said the Jefferies report.

Highest small-cap buying by mutual funds in December quarter
Source: Prime Database (*Net buy has been calculated by multiplying the difference in September and December shareholding by the average closing price during the Quarter)

New-age companies show high growth potential
When it comes to growth potential, new-age companies are the best amongst equals. Gurugram-based logistics startup Delhivery topped the list of mid-cap companies that saw the most buying by mutual funds in the December quarter.

PB Fintech, the parent company of Policybazaar and Paisabazaar, came fifth on that list.

This comes amidst mixed earnings growth from new-age technology companies and as analysts say the long-term growth potential of these companies is huge in spite of the short-term challenges.

Mutual funds bought the highest shares of Delhivery worth ₹1,224 crore in the December quarter. On a sequential basis, its net loss declined 23% to ₹195 crore, but on a yearly basis it surged nearly 55%.

The company also said that its adjusted EBITDA margin improved 330 basis points to -3.7% in Q3 FY23 from -7% in Q2 FY23.

On the other hand, investors are excited about PB Fintech’s course to profitability soon. The December-quarter performance of the company was another surprise for investors as the company narrowed its losses significantly.

Its insurance premiums jumped 70.3% on year to ₹3,030 crore driven by a strong showing across segments.

Further, the management expects revenue and margins to improve further as agent productivity rises, among others. They hinted at a sharp profitability uptick in Q4, say analysts.

Highest mid-cap buying by mutual funds in December quarter
Source: Prime Database (*Net buy has been calculated by multiplying the difference in September and December shareholding by the average closing price during the Quarter)

Strong balance sheets
Analysts say that most mid- and small-cap companies have strong balance sheets with low debt except certain pockets with high valuation.

“I don’t think survival is a challenge for most mid- and small-cap companies as balance sheets of corporate India are fairly strong with low leverage,” said Ravuri, adding that they are seeing growth challenges in certain pockets.

Like in the case of most stocks, those that are trading at lofty valuations in anticipation of higher growth might see troubles ahead in case of any slowdown.

“Any kind of negative news would impact mid- and small-cap stocks more than large-cap ones as volatility is much higher here,” Haldea said.

Yet, unlike their larger peers, small- and mid-caps are more agile and are better positioned to take advantage of any growth going ahead, making investors throw their weight behind these riskier bets.

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