Indian micro-cap, small-cap and midcap stocks have had a strong run in the last few months. A growing number of new participants entered the equity markets, as evidenced by the rise in new demat accounts and increased investments in small and mid-cap mutual funds compared to large-cap funds. Since April 2023, ~60% of incremental mutual fund flows have been directed towards small/mid cap schemes totalling >28,000crs. This has led to smaller companies’ valuations becoming relatively more expensive compared to both their historical levels and large-cap stocks in general. To us, this points to a level of complacency in the market participants. We have seen similar instances in the past where liquidity and flows result in an exuberant market where it seems all too easy to make money, where valuations and fundamentals are set aside for a ‘quick trade’ and rarely does this end well. We are seeing signs of exuberance in the IPO market too and significantly higher instances of selling by insiders/promoter/financial sponsors. For instance, SME IPOs receiving bids of 300-500 times their offer size have become commonplace, such as Kahan Packaging’s < 6 crore IPO, which garnered bids of nearly 4,000 crores.
Near term risk: reward in the smaller/mid cap stocks remains unfavourable and we are hunting for value in the larger cap stocks and/or sections of the market which have been largely neglected by the market given short term/cyclical pressures on business. We have added a few such names to our portfolio in the last few months – where the stock price may not perform well in the short term as these businesses emerge from a cyclical downturn or face global market pressures. However, we believe valuations provide sufficient comfort. We like these businesses as they have strengthened their balance sheet and competitive position over the past few years when the external environment has been challenging and continued to invest in capacities and capabilities. In general, we continue to eschew near term momentum and prefer to take the ‘pain’ of underperformance in the short term rather than suffer serious loss of capital by buying into ‘fads’ at nosebleed valuations. We are holding 8-10% cash in mature portfolios and for newer investors, cash levels are higher while we continue to be on the lookout for opportunities with suitable risk-adjusted returns. As you are aware, we have always run a market cap and benchmark agnostic portfolio but recognise the human tendency to compare performance. Just the way it is next to impossible to consistently call the bottom of the market, it is equally difficult to call the top. If the liquidity fuelled rally continues in the markets for the next few months, we are prepared to suffer some underperformance as we remain confident that once valuations and market sentiments revert to some level of sanity, we should be able to make up for any loss of performance vs. the market indices.
We are heading into a heavy election season in India starting with 5 state elections during the months of November and December. Typically, populism trumps prudence in politics and we as market participants need to be watchful that the current macro/fiscal environment does not get too muddled. On the global front, India clearly sits in a sweet spot in terms of the growth narrative – with China still recovering from its covid closures & real estate meltdown and the Western companies seemingly looking for a more diversified supply chain away from China – we have much to gain if we capitalise on this once in a lifetime opportunity to build factories and create hundreds of thousands of jobs.
Thank you for trusting is with your investments. As always, please feel free to reach out to us in case of any queries.