Analysts said the general pessimism regarding the mid- and small-cap segments led to selling pressure, even in quality stocks. “People today are thinking about a flight to safety and how not to lose money, rather than make significant returns in the next two-three years. And, it happens during every downturn. The only difference this time is that the Sebi’s regulations partly triggered it,” said Samit Vartak, chief investment officer and partner, Sage One Investment Advisors.
Analysts said till small- and mid-caps start giving returns similar to large-caps, new money coming to smaller companies is bleak. They say huge structural changes are required for the valuation parity to kick in.
“For the situation to improve, we need a faster and hassle-free takeover process and lesser protection to incumbent managements. And small- and mid-cap companies should improve capital allocation decisions, including higher payouts in the form of dividend or buybacks,” said Deepak Jasani, head of retail research, HDFC Securities.
Sebi’s reclassification exercise, which came into effect from July 2017, resulted in an outflow from mid- and small-cap stocks to large-caps. According to Sebi norms, large-cap funds could invest in the top 100 stocks in terms of market capitalisation, mid-cap funds can invest in the top 101-250 stocks, and small-caps can invest in stocks ranked from 251.
The new norms led to buying being concentrated upwards, leading P/E and P/BV expansion for the top 100 stocks.
Analysts said, ideally, investors should not differentiate stocks based on the market cap and base their investment decisions on a company’s fundamentals. For example, a company, which is a leader in a small industry, will not be a large-cap because of the size of the sector. However, it will have a similar competitive advantage as a leader in a large sector.
Market players said that Sebi should make its reclassification norms a bit more flexible. It must put some restriction on the average market cap of firms, instead of classifying the top 100 companies as large-caps, they felt.
“Maintaining certain risk metrics of the portfolio, such as liquidity and weighted average market cap, may be considered by the regulator. This will provide more flexibility to the fund manager without compromising on the risk profile of the portfolio,” said Vartak.