Blasé Capital IS SMALL BEAUTIFUL?

You can decide whether this bottle full of stocks is half-full, or half-empty. A recent study shows that half of the small-cap stocks, which have respective market caps between INR 2,000 crore and INR 34,700 crore, are currently quoted at prices that are more than 40 per cent lower than their peaks. For many, this may imply that investors, especially those who purchased these mostly-penny stocks nearer to their peaks, have incurred huge losses. Possibly, they need to stay away from them, and focus on less-risky stocks, which have clearer financial and operational journeys. However, Abakkus Mutual Fund, which conducted this study, feels that these steep downward corrections may “create a potential accumulation window to acquire high-potential businesses at more sustainable valuations before the next growth cycle begins. This will also create opportunities for the investors to make strategic long-term investment allocations in the small-cap space.”

Normally, small-cap stocks offer higher risks due to several factors. For example, they are highly-volatile, and highly-sensitive to market movements, news, and macroeconomic trends. When the indices go up, small-caps can rise faster than the mid-caps, and large-caps. But when the indices go down, the smaller stocks fall more sharply than the others. Small-caps, obviously, have lower public float and, in most cases, the promoters and large shareholders own the bulk of the share capital. Hence, lower trading volumes implies that buyers can struggle to sell without major impacts on stock prices. Despite promises, small-cap firms face challenges to expand, grow, and scale up. According to AI tools, “Limited analyst coverage, and media attention make it harder to conduct thorough research, with less accessible data compared to the large-cap companies.” Smaller stocks face high compliance costs, and regulators look at them more carefully, and regularly.

“Investors have an opportunity to accumulate fundamentally strong businesses at sustainable valuations before the next growth cycle unfolds. A meaningful portion of (small-cap companies… are now available at improved risk-reward levels. Most important, exposure to sunrise industries and varied sectors that are difficult to access in the large-cap space, are majorly available in the small-cap category,” counters Vaibhav Chugh, CEO, Abakkus Mutual Fund. According to the fund, small-caps offer exposure to the emerging ad sunrise sectors, which shape the nation’s growth story. These include areas such as defence, aerospace, pharma, biotech, electronics, electric vehicles, batteries, AI-led services, renewables, and medical devices. Most of these sectors are driven by small firms, especially in India which does not have tech giants like Google and Apple, and start-ups. Hence, the opportunities to invest in such sectors lie only through small-cap stocks, which may have just entered the stock market.

One can look at the small-caps in another way. One can look at the slightly long-term returns from them, and compare it with those from the mid-caps, and large-caps. According to Abakkus, “Small-caps are typically associated with higher volatility, compared to large-caps. However, the study shows that despite the higher standard deviation, Nifty Small-cap 250 SIP returns has delivered superior long-term growth with a CAGR (compounded annual growth rate) of 17 per cent in comparison to the Nifty 50 SIP returns of 12 per cent, since September 2016, or a 10-year.” The Nifty Small-cap 250 beats the Nifty 50 even on three-year, and five-year comparisons. The former recorded a CAGR of 21 per cent, and 22 per cent, respectively, compared to 13 per cent for both periods. However, the 10-year period starts on September 1, 2016, and lasts till January 31, 2026. One is not sure what will happen to returns if the start date is shifted to January 1 or 2, 2016.

“The better long-term return delivered by the small-caps reinforces the importance of staying invested through cycles rather than attempting to time the market,” explains Chugh. However, most experts contend that while small-caps may provide better returns in the long run, the fact is that they are not guaranteed to beat large-caps in every market condition. Hence, the periods when these small and penny stocks are purchased, and when they are sold. Due to high volatility, the variations between the highs and lows of the small stocks can be higher than the differences in mid-caps, and large-caps. It may be better to invest in small-cap mutual funds, rather than small-cap stocks, as the average cannot overrule the specifics. While on average the small-cap index may give superior returns, individual stocks can plummet, and become either penny stocks or worthless, which cannot be sold. Amateur investors are generally saddled with such stocks.

A question that creeps up is a logical one. If the average returns from small-caps are better, why does one invest in the latter category? There are two answers. One, the average does not equate with specifics. The average may be positive, but the stocks an investor holds may tank. Small-cap mutual funds may be a better option, but in unsteady times, they perform worse, and that may be the time when you need the money. The second is because of higher volatility, the stress levels are high. If a small-cap tanks, one may pump more money, get good money to chase after the bad, and the stock may never recover. The chances of a recovery is higher in the cases of mid-caps, and large-caps.