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Mid-, small-cap mutual funds have started rallying. Is it time to invest?

In the last 15 days, mid cap and small cap indices have gained between 3-5%, as soaring valuations in large cap stocks along with ample liquidity started chasing quality stocks in these segments.

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Last Updated: Jan 17, 2020, 10.56 AM IST
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Mid cap and small cap stocks have been rallying since the beginning of 2020. In the last 15 days, mid cap and small cap indices have gained between 3-5%, as soaring valuations in large cap stocks along with ample liquidity started chasing quality stocks in these segments. Riding on the wave, even the mid cap and small cap mutual funds, which were beaten down badly in the last two years, started inching up once again in the last few months. The small cap mutual fund category has returned 7.78% in one month and 4.40% in one week. Similarly, the mid cap mutual fund category has offered 5.00% in one month and 3.83% in one week. Is the revival finally here? In other words, is it time to invest in these schemes?

“After the budget, we are expecting a mid cap rally. The recent uptick in the small and mid cap indices is because of the liquidity moving to these segments from the large caps. A narrow-based rally in the large cap segment has left out most of the large cap stocks, so the money is finding value in the mid cap segment,” says Jimmy Patel, MD & CEO, Quantum Mutual Fund.

Mutual fund managers have been saying that the risk-reward is in favour of the mid cap and small cap stocks for a long time. Mayur Patel, fund manager, IILF Mutual Fund, says that since December 2019, the discount on stocks in the mid cap segment is around 20%. "Compare the discount in small and mid caps to the large cap segment where the premium is high and all the stocks are not performing. The money will thus flow to mid caps and small caps,” says Mayur Patel.

Does this mean the much anticipated recovery is taking place currently? Well, there are few catches here. One, the entire segment is unlikely to bounce back in style in the near term. Two, mid caps may be better placed than small caps to attract the excess liquidity. Three, the revival may be very stock specific because of the uncertainties faced by the economy.

Mutual fund managers ask investors to go slow on mid cap and small cap bets. They believe that the market will not behave like it did in 2016, when every stock, including the low-quality ones participated in the rally. “We are expecting a rally which will be led by stock from mid cap segment. All the companies from mid and small caps might not be a part of this rally like 2016. It will be essentially a rally in good quality, high governance standard companies,” says Jimmy Patel.

Jimmy Patel says investors should be extremely careful about small cap funds as they are still a risky bet.

Even though the small cap segment has risen more than the mid cap segment in the last two weeks, mutual fund managers expect mid caps to do better than small caps in this year. "Small caps will also catch up but the small cap universe has governance and quality issues that the market is really sensitive to at this point in time. I believe that quality small cap stocks, will participate in the rally. And hence the stock picking plays an important role here," says Mayur Patel.

“The rally in bigger mid cap companies is expected to outshine other segments. It will take a good 5-6 months for them to catch up and start outperforming the broader market. Investors should not jump the gun,” says Mayur Patel.

Fund managers believe mutual fund investors should not start investing in small and mid cap funds expecting a rally. Rather, they should stick to their asset allocation. “Don’t go overboard expecting a rally. Stick to your asset allocation and goals. If your allocation to mid and small has come down in the last one year, re-balance your portfolio,” says Jimmy Patel.

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