MFs sound caution on ‘excessive’ valuations in mid & small-caps

The share of mid-cap and small-cap companies in India’s total market value hit the highest level in May, boosted by the unabated appetite for these shares among domestic investors. This, however, warrants caution, said fund managers, who warned that the sharp run-up in these shares may be excessive for now.

According to a study by ICICI Prudential Mutual Fund, the share of mid- and small-cap stocks to the country’s total market capitalisation was at 36.3% in May, compared to 25% in Dec 2020 and 19.6% in Dec 2013. Meanwhile, the contribution of the large caps declined to 63.7% in May, compared to 74.2% in December 2020 and 80.3% in December 2013.

“We are observing excessive valuations in this segment, which raises concerns about potential returns relative to the risks involved,” says Anish Tawakley, co-CIO equity, ICICI Prudential AMC. “We believe the current risk-return trade-off in the small- and mid-cap space is not attractive.”

Mid-caps and small-caps have outperformed their large-cap counterparts in the past three years. While the Nifty rose 26.34% and 15.82% over one- and three-year periods, the Nifty Midcap 150 has returned 57.46% and 28.05%, respectively. The Nifty Smallcap 250 rose 61.72% and 27.33%, respectively.

“In past 12 months, small- and mid-cap stocks have led Indian markets, with valuation-led gains surpassing earnings-led gains,” says Krishna Sanghavi, CIO – equities at Mahindra Manulife MF. Large-cap valuations are more favorable, he said.

The outperformance has resulted in valuations of small-cap and mid-cap stocks shooting past their long-term averages.