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Small-cap mutual funds catch investor fancy with Rs 11,000-cr inflow, large-caps lag

Small-cap mutual funds catch investor fancy with Rs 11,000-cr inflow, large-caps lag

Mutual funds that concentrate on small-cap stocks have experienced substantial success, recording a net inflow of nearly Rs 11,000 crore in the April-June quarter. Fund managers have encountered challenges in generating alpha, or excess returns, in the large-cap space, contributing to the shift in investor preference towards small-cap funds. This trend is anticipated to persist for a considerable period.

Conversely, the large-cap space has struggled to gain momentum and faced an outflow of Rs 3,360 crore during the quarter, as indicated by data from the Association of Mutual Funds in India (Amfi).

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The net inflow into small-cap funds and the outflow from large-cap funds reflect the changing investor sentiment and their quest for better returns in a market where large-cap stocks have been less dynamic. Investors are gravitating towards small-cap funds in search of potential opportunities for higher growth and returns.

The data from Amfi highlights the growing interest in small-cap funds and the challenges faced by fund managers in generating alpha in the large-cap segment. This shift in investor behavior underscores the dynamic nature of the mutual fund industry and the importance of adapting investment strategies based on market conditions and investor preferences.

AMFI - Association of Mutual Funds in India

In addition to the inflows observed in the June quarter, small-cap funds in India received an inflow of Rs 6,932 crore over the three months ending in March. This surge in inflows can be attributed to the strong rally witnessed in the mid and small-cap indices in recent months. As it becomes increasingly challenging to generate alpha in the large-cap space, investors are turning towards small-cap funds for potential outperformance.

Himanshu Kohli, Co-founder of Client Associates, noted that the substantial inflows into small-cap funds have led fund managers to exercise more caution in their stock selection. This cautious approach is driven by stretched valuations resulting from the increased investor interest in small-cap stocks.

The impressive performance of mid and small-cap indices in recent months, coupled with difficulties in finding alpha in the large-cap segment, has driven significant inflows into small-cap funds. However, fund managers are being mindful of stretched valuations and are adjusting their stock selection strategies accordingly.

Mukesh Kochar, National Head-Wealth at AUM Capital Market, highlighted that the performance of small-cap stocks has been remarkable in recent months. He explained that this exceptional performance can be attributed primarily to the valuation gap between small-cap and large-cap companies. This trend typically occurs when overall market conditions become expensive, leading fund flows to concentrate on specific stocks.

During such market scenarios, fund managers actively seek out value or identify pockets of opportunity that may be available at the lower end of the market spectrum. This means that despite the overall market being expensive, certain small-cap stocks offer attractive valuations and growth potential, attracting investor interest and driving their exceptional performance.

Fund managers take advantage of these opportunities by targeting undervalued small-cap stocks that have the potential for significant upside. By focusing on areas where value can be found, fund managers aim to generate alpha and outperform the broader market.

In summary, according to Mukesh Kochar, the exceptional performance of small-cap stocks can be attributed to the valuation gap that arises when markets become expensive. Fund managers actively seek out undervalued small-cap stocks, leveraging their potential for growth and capitalizing on opportunities that exist within this segment of the market.

Feroze Azeez, Deputy CEO of Anand Rathi Wealth, pointed out that investors are favoring small-cap funds because they offer higher growth potential while maintaining similar risk levels compared to mid-cap funds.

The small-cap category within the mutual fund space has delivered impressive returns, with compound annual growth rates (CAGR) ranging from 30-37 percent for one year, 40-44 percent for three years, and 18-21 percent for five years.

Over the past five years, the small-cap universe has nearly doubled in size, increasing from 8,580 crore in 2017 to 16,400 crore presently. Additionally, the rise in the market capitalization of small-cap companies has reduced certain risks associated with small-cap stocks, such as illiquidity and higher volatility.

To summarize, Feroze Azeez highlights that investors are attracted to small-cap funds due to their potential for higher growth while maintaining comparable risk levels to mid-cap funds. The small-cap category has delivered impressive returns over the years, and the increase in market capitalization has helped mitigate some of the risks traditionally associated with small-cap stocks.

The significant inflows into small-cap mutual funds have led to a substantial increase in assets under management (AUM). The AUM of small-cap funds surged by 28 percent, reaching Rs 1.7 lakh crore at the end of June, compared to Rs 1.33 lakh crore at the end of March.

Among the preferred sectors for small-cap mutual funds, auto & ancillaries, capital goods, and IT stand out, collectively accounting for 23 percent of the overall asset base. Additionally, multi-asset allocation funds have also gained popularity among retail and high-net-worth investors in recent years.

According to Mukesh Kochar of AUM Capital Market, the inflow trend into small-cap funds is expected to continue for the foreseeable future. It is important to note that although there are some valuation concerns, the long-term growth prospects of India continue to attract liquidity, contributing to the ongoing inflows into small-cap funds.

In summary, the inflows into small-cap mutual funds have propelled the growth of assets under management. Auto & ancillaries, capital goods, and IT are the favored sectors among small-cap funds. The trend of inflows into small-cap funds is anticipated to persist, driven by liquidity seeking long-term growth opportunities, despite some valuation concerns.

Anand Rathi’s Feroze Azeez recommends that investors consider allocating up to 30 percent of their portfolio to funds in the small-cap category, while maintaining a 50 percent allocation to large-cap funds at the portfolio level. This suggests that while small-cap funds may appear attractive, it is important for investors to strike a balance by diversifying their portfolio with a combination of small-cap and large-cap funds.

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