Multi-cap funds run the risk of missing out on the mid- and small-cap rally

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The multi-cap schemes, which have the flexibility to invest in stocks across a wide spectrum of market capitalisation, run the risk of missing out on the mid- and small-cap rally as they continue to stick with large-cap stocks. 

According to an analysis of the data from Value Research, large-cap exposure of multi-cap schemes has increased from 62 per cent at the end of 2017-18 (FY18) to more than 68 per cent at the end of January 2019. Meanwhile, exposure to mid-cap stocks has reduced from 21 per cent to 19 per cent; exposure to small-cap stocks has declined from 9.3 per cent to 6.4 per cent in the same period. 

Of the 32 multi-cap schemes, 22 have deployed 65-95 per cent of their funds to large-cap names.

“We see that most of the multi-cap funds have become like large-cap funds. Mid-cap exposure is not even touching 20 per cent when we look at average exposure. Just when we think that the potential in mid-caps might be slightly higher due to correction in valuations, investors are not getting that exposure through multi-cap funds,” said Tushar Pradhan, chief investment officer of HSBC Mutual Fund (MF). 

Pradhan pointed out that the expected two-three year earnings growth is not in the price for some of the mid-caps.  The corrections in mid- and small-cap stocks and expected earnings growth have made analysts bullish on the segment. The Nifty midcap’s earnings are expected to compound at 22 per cent over FY19-FY21, according to analysts’ estimates. 

“The price-to-earnings (P/E) premium of mid-caps versus large-caps rose to 46 per cent in FY18. However, after the correction in mid-caps, the P/E premium stands at 10 per cent,” said analysts at Motilal Oswal Financial Services in a recent note. The analysts added that on a price-to-book basis, the Nifty Midcap 100 Index is trading at a 12 per cent discount to the Nifty. 

Analysts tracking the MF industry say most fund managers are likely to stay biased towards large-caps despite the correction in valuations. 

“While fund managers admit that valuations for mid-caps have become relatively cheap, they are still treading with caution due to expected volatility ahead of the elections. We could see some inching up of exposure towards mid-caps, but there won’t be any major shift overnight,” said Kaustubh Belapurkar, director of fund research at Morningstar India. 

After seeing a sharp run-up in previous years, the mid- and small-cap stocks saw sharp correction last year. In 2018, the BSE MidCap and the BSE SmallCap index declined 13 per cent and 23 per cent, respectively.
Market experts say the lack of pick-up in earnings, corporate governance, and liquidity-related issues, along with expensive valuations, were major contributing factors to the decline of these companies. Recently, the BSE MidCap and the BSE SmallCap indices have delivered positive returns for three weeks in a row, gaining 8 per cent and 11 per cent, respectively.

Analysts say this recent spurt in prices could turn into a sustainable rally.  “Our economist expects the Reserve Bank of India to cut rates further in its April policy meeting. The recent purchasing managers’ index and our proprietary economic activity index suggest a strong start to 2019. Our analysis of fundamentals and valuations for mid-caps and comparing mid-caps versus large-caps on several frontiers suggest that the relative attractiveness of mid-caps has gone up,” analysts at Motilal Oswal Financial Services said.

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