Shift to large-caps expected as Smids are richly valued

While the Nifty shed 3.35% from its peak of 20,222.45 on 15 September to its closing of 19,545.75 on 5 October, the Nifty Midcap 150 has fallen almost 4% from its peak of 15,599.05 on 12 September to 14,975.70 on 5 October. However, the Nifty Small-cap 250 index has pulled back just 2.66% from its 12 September peak to its current close of 12,238.55. Analysts expect this to decline further.

The rise of the smids indices from March lows to September peaks underscores the outperformance of the indices thanks to direct and indirect retail flows into them.

While Nifty rose 20.16% from its 20 March low of 16,828.35 to its mid-September peak, the mid-cap and small-cap indices rose twice as much, thanks to investors pouring money into mid- and small-cap schemes of mutual funds at the cost of large-caps, aside from a chunk of direct retail flows of ₹14,400 crore in August after a five-month hiatus, according to NSE data.

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For instance, stand-alone mid-cap schemes of mutual funds attracted flows of ₹10,999.73 and small-cap schemes ₹21,803 crore from March to August. Large-cap schemes witnessed outflows of ₹4,676.95 crore in comparison. What saved the day for large-caps was ₹1.69 trillion inflows from FPIs from March to August and part of ₹14,400 crore from retail direct in August flowing into them.

However, the higher flows into smids have pushed their valuations way above the large-caps, and this could actually result in profit booking in them, said market experts.

For example, current PE ratio of REC, one of the top mid-cap performers, at 6.29 times, is nearly two times its three-year average PE (3.4 times), while the top small-cap performer Suzlon Energy enjoys a PE of 66.68 times against the three-year average of 12.87 times.

In contrast, Nifty heavyweight Reliance Industries Ltd’s PE is currently 24.18 against its three-year average of 25.56, while that of another large-cap outperformer, Larsen & Toubro Ltd, is at 38.63 against the three-year average of 39.24, according to Bloomberg data.

“While rising bond yields in the US could result in a possible 5% further correction in indices, my sense is that fund flows will be diverted from mids and smalls into large caps, given the relatively more attractive valuations in the latter over the next few months,” said Nirmal Jain, chairman of IIFL Group.

Dhiraj Relli, managing director and CEO of HDFC Securities, also expressed concerns about overheating following their recent surge.

“In case their results do not meet raised expectations, investors could be disappointed, and some correction could be seen in them. Also, if the general risk appetite of investors falls, we could see a shift from these segments to large caps. The BFSI, auto and auto ancillary, and hospitality large caps offer good investment opportunities in a staggered way,” Relli said.

Mutual fund officials also said they saw a slowdown of inflows into mid and small-caps last month.

“We have a sense that September has witnessed a slowing down of flows into mid- and small-caps,” said Nityanand Prabhu, executive director and business head of LIC Mutual Fund. “There will be some more attraction in flexi-caps and large-caps.”

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Updated: 07 Oct 2023, 12:28 AM IST