Why small caps saw surge in June?

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Since the last few months, small-cap stocks have shown tremendous outperformance. The major reason for this could be the valuation gap between small-cap companies and large-cap companies. This always happens when markets become a little expensive but the fund flow chases stocks. In such type of market, fund managers try to find out values or pockets of opportunities on a comparable basis that are available at the lower end of the radar. These stocks are with a low base and can grow at a higher pace compared to large companies in terms of percentage growth and are undiscovered stories. Hence higher risk higher reward. The massive fund flow via mutual funds, PMS or direct equity investors has added more momentum to it. If you see the performance of small-cap funds in the mutual fund space, the 5-year CAGR is around 18-21%,3 years @40-45% & 1 year @30-37%.

Even in the last 6 months, they have given a return of around 12-15% absolute. So when fund performance improves or outperforms, money chases and vice versa. So broadly two major reasons for massive flows in small-cap funds. One is the valuation gap & the other is the performance. Investors should moderate return expectations going forward and should consider this small-cap category for 5 year plus time horizon with a proper asset allocation framework.

In recent AMFI data, small-cap funds are clear winners along with value funds with small cap getting the highest net inflow of Rs 5471 cr and Large-cap has been the loser with a net outflow of Rs 2,049 cr. Multi-asset allocation funds have also started to gain some momentum of late with retail and HNI investors. The small-cap fund flow trend may continue for some time as I said this always happens when the Market is at its peak and there are some concerns over valuation but liquidity is chasing the long-term India story. Fund managers try to find value stocks with more legs of opportunity.

Retail money chasing the market is at an all-time high and at the same time HNIs & family offices are flushed with liquidity. HNI & family offices generally follow market trends and currently, the trend is in favour of small cap, mid-cap & Value stocks. This should continue for now. The Arbitrage fund also got a net inflow of Rs 3,365 cr and the ultra short term fund ended with net outflow. This show that the corporate treasuries & HNIs have shifted short term money from ultra short term funds or money market funds to arbitrage funds as the spread is attractive since last few months along with tax arbitrage & short term liquidity. One to four year duration segment of the debt fund has also attracted reasonable inflow as the yield is very attractive.

Nippon small cap, HDFC small cap & SBI small cap has done well consistently within small cap fund space.. Diversification is the most important factor as far as small cap is concerned. At the same time, he has been able to outperform the benchmark consistently with early entry in the stocks. Most of these funds follow value strategies as this segment is all about value but these fund mangers tried to buy value with growth and that has paid of well. Most of these funds have grown heavily in size and are currently between Rs 20-30k cr of AUM. Now the challenge lies in managing such a large size of funds in small cap space due to small floating stocks and liquidity.

Author is National Head-Wealth, AUM Capital Market. Views are personal.