Sprinters run fast but they run only a short distance. While marathon runners run at a slower speed but run miles. Stocks are just like runners. A few run too fast in no time; while others move gradually. Still, people tend to get attracted to those which give quick returns. Unfortunately, many of us think of buying stocks when they look exhausted – having run-up a lot in euphoric times and not in times of panic. While at PersonalFN we recognise that it is quite challenging to time the market, we believe it is imperative to give due respect to valuations.

Now that the current market rally has sustained for about a year and the market having scaled a new high, retail investors have started getting back to market. A comparative analysis of returns clocked by various categories of the market capitalization segment reveal that the mid and small cap oriented funds, have outperformed the large cap ones over last 1 year. Nonetheless, large cap funds have beaten their respective large cap indices. Also, a few mutual fund houses having dedicated funds for exploiting opportunities in the small and micro-cap domain have also clocked appealing returns while assuming very high risk. You see, some of them have nearly doubled since their inception – at a time where a number of fund houses launched New Fund Offers (NFOs) in early period of 2014.

It has been observed that, aggressive funds in the mid and small cap category attract more assets after they record impressive performance. A similar trend has been observed in the current market rally. In the quarter gone by, (July- September) broader markets fell from their all-time highs. The fall was nominal in large caps, moderate in mid caps but was sharp in the small cap domain.
 

Do smallcaps look attractive on valuations?

Data for the July to September quarter
(Source: Ace MF, PersonalFN Research)  

The valuation chart given above may give you a feeling that, small caps look more attractive than the large caps. However, it is noteworthy that, historically, large caps trade at premium valuations to small caps. Furthermore, valuations may suddenly start looking expensive if smaller companies fail to record higher growth.

What mutual funds are doing?
Mutual funds are bound by their mandate. A midcap or a small cap oriented fund has to invest in smaller companies. If investors keep pumping money in, mutual funds have to keep deploying it in stocks of mid and small-sized companies. A sudden gush of investments makes things difficult for the fund manager. There are restrictions as to how much cash a fund can hold in its portfolio. More the cash a fund holds in its portfolio, greater are the chances that it would underperform. Since investors are taking bullish calls on mid and small cap oriented funds, mutual funds are also hiking their exposure to smaller companies. However, they are going very stock specific. This is why exposure of mutual funds to a few smaller companies has gone up considerably in the recent past. A fund manager has to be very alert when he is putting money in small caps, as there are many uncertainties.

PersonalFN is of the view that, investors need to tone down their expectations. It would be bold to assume that markets will maintain the same momentum even in future as they have shown over last 1 year. Small caps may run too fast but they can plunge sharply when the momentum reverses. This is why PersonalFN believes investors need to observe caution and invest in large cap and multi-cap and / or flexi-cap oriented funds when valuations appear stretched.

Mutual Funds can’t make you wealthy overnight. You should opt for Systematic Investment Plans (SIPs) offered by mutual funds and invest for the long term in schemes that have a consistent and an appealing performance track record across timeframes and market cycles.

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8agr2q6tolx@yahoo.com Jan 07, 2015 Whoever edits and pubslihes these articles really knows what they're doing.

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