Historical data proves that during volatile stock market and/or stressful macroeconomic conditions, large cap funds or funds that invest in large companies perform better. As we write this in the August of 2017 last 4 years data shows that Small cap & mid cap funds have delivered returns equivalent to 3 times that of large cap funds. This data from the immediate past convince an investor that small and mid caps are the way forward. We at Mutualfundwala do not subscribe to this notion. We have been recommending our investors to refrain investing in small and mid cap funds. As the valuations are expensive and in case of a downturn, mid and small cap funds are likely to get hammered. Moreover, last few years earnings growth is way below expectations. Moreover, in smaller companies’ negative effects of demonetization and GST implementation are still visible.
Let us explain why small and mid-caps have rallied so much. When the New Modi led government took charge small and mid-cap funds were severely beaten down. They rallied mainly on “valuations catch up” than on fundamentals. Besides, a new pro-reform stable government aided frenzy buying.
These overpriced BSE Mid and Small Cap indices are well over their respective all-time highs. In last 2 years, Sensex has given absolute returns of 31%. Whereas, in the same period Mid cap and Small cap indices have generated absolute returns of 88% to 99%.
The point of debate in the middle of 2017 is what next? We at MutualFundwala expect large companies or large cap oriented funds to outperform Mid and small cap funds. The reasons are several. Firstly, Large cap stocks are undervalued (at least as compared to small and mid-cap peers). Trailing PE (Price to earnings) of NSE Midcap 50 is over 40 and NSE 50 is around 22. Secondly, Capacity utilization in large companies is under 70%. This implies as and when demand revives large companies can produce and sell more and this is without capital expenditure. Lastly, large companies are better placed to weather demonetization and GST implementation.