Rebalance your equity portfolio with small cap mutual funds

Small-cap funds have done fairly well in May, outperforming their large- and mid-cap peers despite the fact that the overall equity mutual fund space is not doing too well. Investors underweight on smallcaps should look to rebalance their portfolios by investing in them but becoming overweight, from here, may not be the best approach.

Small-cap funds have received much better response from those who invested Rs 5,464 crore in this category in the last two months. In comparison, the mid-cap funds witnessed inflows worth nearly Rs 3,000 crore. However, large-cap funds have borne the maximum brunt with net outflows of Rs 1,362.28 crore in May.

Alekh Yadav, Head of Investment Products & Solutions at Sanctum Wealth, said the current traction towards the small- cap funds have been on the back of attractive valuations in these stocks. “After the lows of March 2020, smallcaps rallied hard up till December 2021 making them highly expensive relative to their large-cap peers. This led to their underperformance. But, by the end of March, smallcaps’ valuations had become reasonable and hence we have seen a rally over the last couple of months,” Yadav explained.

His advice to investors who have been ‘underweight’ on small-cap stocks is to rebalance their portfolios with the same. Those who have already been ‘overweight’, should avoid being more bullish. “Currently smallcap valuations relative to large caps are close to historic averages. Hence, we don’t suggest investors to become overweight,” Yadav said.

Abhishek Banerjee, Founder & Chief Executive Officer at Lotusdew Wealth, said small-cap stocks traditionally exhibit stronger performance over a full market cycle, and it appears that asset allocators are adjusting portfolios by reducing exposure to large-cap stocks and increasing investments in smaller companies.

“This reallocation reflects a strategic move based on the belief that smaller companies may offer greater growth potential and investment opportunities in the current market conditions,” Banerjee said.
Report Card
As an asset class, equity mutual funds have witnessed significant redemptions in April and May as investors have booked profits to capitalise on the uptrends after the underperformance of stock markets in the March quarter.
The combined net inflows in equity mutual funds in April and May across all categories was just over Rs 9,700 crore as against redemptions/repurchases totaling to Rs 46,490 crore during this period.

Deepak Jasani, Head of Retail Research, HDFC Securities, said investors remain wary of committing large lump sum monies into equity funds at the current levels of the stock market. This is also a reflection of the opportunities available in the secondary market for direct investing at a time when small- and mid-cap stocks have been outperforming.

“While gross flows into equities were strong, we saw redemptions’ possibility due to profit booking in a rising market. This led to net flows declining significantly in May. Additionally, NFOs tend to skew equity MF flow data significantly, in May. We did not have too many NFOs. This is another reason for the decline in inflows,” said Yadav of Sanctum Wealth.

Acknowledging the lack of optimism in equity MFs despite the stock markets performing well in April and May, Lotusdew’s Banerjee said investments in India primarily come as a discretionary expense like leisure, consumer durables, and textiles.
“May was associated with increased spending on vacations, coinciding with the non-harvest season in rural India and a general shift away from the markets,” he added.

On significant redemptions in large-cap funds, Banerjee said large-cap stocks have consistently outperformed smaller company indices over the past 18-20 months and hence there is a shift being seen in this space. Though investments via the SIP (Systematic Investment Plans) route have remained stable, there are also one-time purchases driving inflows, he added.

Yadav of Sanctum also highlighted strong show from the large caps during most of the last year, which was better than the performances of mid- and small-cap stocks. In the last two months, the situation has just reversed, he said. The underperformance of domestic markets during the January-March quarter led to significant corrections in the small cap stocks. “Investors are now also looking to rebalance portfolios,” yadav said.

Debt Versus Equity
While equity funds have struggled, the debt mutual fund schemes have received a thumping response from the investors with net inflows of Rs 1.5 lakh crore in the last two months. Investors have banked on liquid funds for short-term gains.

According to Jasani of HDFC Securities, the large debt fund inflows in April and May reflect parking of surplus monies by companies for temporary periods as the liquidity in the banking system has remained tight and the short-term rates were attractive. “Post the abolition of indexation benefits in the recent Budget, debt fund inflows are concentrated in the short end to benefit out of high rates in the banking system prevailing in the short term and to park short term surplus,” he said.

Asset Allocation
“Don’t put all your eggs in one basket. Diversify your investments as per your financial goals. Equity is a long-term investment. Don’t expect to get rich overnight. Be patient and let your investments grow over time,” Adhil Shetty, Chief Executive Officer at said.

On comparisons with debt funds, he said investors must realise that debt funds are not a substitute for equity funds. “A diversified portfolio that includes both debt and equity funds is the best way to achieve long-term financial goals,” Shetty said.
Jasani of HDFC Securities highlighted the importance of asset allocation for investors. Equity investors need to maintain asset allocation balance and take some profits in bullish times and invest more in equities in bearish times, he said.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)