Mid- and smallcap indices may be scaling fresh highs, but the rally is far from broad-based, according to TrustLine Holdings Founder & CEO N. ArunaGiri. Unlike the one-way momentum seen across the segment in 2024, the current market is being driven by sharp divergence, with investors rewarding companies delivering earnings growth and punishing those with weak earnings visibility. As reported by ETMarkets, the current rally in small and mid-caps is very selective and stock specific, with extreme divergence between winners and losers. Recent data from ETMutualFunds analysis shows that among 163 funds that have completed seven years of existence, Bank of India Small Cap Fund delivered the highest CAGR of 25.21% over the period, significantly outperforming peers with returns ranging from 9.14% to 22.97%. The fund's performance is particularly notable given that it has not offered the highest return in any calendar year nor lost the most in these periods, demonstrating consistent long-term outperformance.
The large-cap segment is experiencing significant pressure, with the BSE 100 index declining 0.46% on the day and extending its five-day decline to 1.42%. Market breadth within large-caps remains severely subdued, with only 24 stocks advancing while 76 declined, resulting in an advance-decline ratio of just 0.32x. Among large-cap constituents, HCL Technologies emerged as the best performer with a robust 5.95% return, highlighting the preference for defensive stocks with strong fundamentals. Conversely, CG Power & Industrial Solutions was the worst performer, declining by 4.07%, reflecting ongoing concerns about operational challenges and subdued demand outlook. This divergence underscores the prevailing risk aversion among investors, who are favoring quality and defensive names over cyclical and high-beta stocks.
With smallcaps also trading at significantly higher valuations than in previous cycles, the key question for investors is whether current gains are backed by sustainable business prospects—or simply momentum feeding on momentum. According to ETMarkets, the number of stocks hitting 52-week lows far outnumbers those hitting 52-week highs, indicating a very choosy and divergent market where index performance masks much wider divergence underneath. The Nifty Smallcap 250 is currently trading around 13% below its estimated fair value, which shows that over the long term, further upside is still possible, as reported by ETMutualFunds. However, investors should ensure they are not falling prey to recency bias and investing in small caps only because of their recent performance. Recent data from ETMutualFunds shows that the Nifty Smallcap 250 is expected to grow by around 27% in FY27 and 33% in FY28, providing support to the segment even after the strong rally.
Domestic liquidity has become a permanent phenomenon, standing the test of time over the last two years, as reported by ETMarkets. FII holdings in the listed space have come down sharply from 18%+ to 14%+ during this period, while DII holdings have spurted to over 18%. This transformation has led to a very discernible shift in small-cap dynamics, with the carnage in small-caps during downcycles being far less pronounced than in earlier cycles. The average multiple in the small and mid-cap space has moved up significantly to around 35-40 times in normal cycles, compared to the historical average of 20-25 times. According to the latest AMFI data, small-cap funds received the highest inflows of ₹7,973 crore, marking the highest-ever inflow in the category, with July alone seeing ₹7,767 crore in inflows, marking a 3% jump month-on-month.
Bank of India Small Cap Fund has demonstrated exceptional performance, delivering a CAGR of 25.21% over seven years among equity funds excluding sectoral and thematic schemes, according to ETMutualFunds analysis. The fund, launched in December 2018, has received four-star ratings from both Value Research and Morningstar. The portfolio is spread across more than 30 sectors with no single sector having a huge allocation, while the largest individual holding is around 3% of the portfolio. The fund is overweight on others at 2.36% in large caps, 7.16% in mid caps, 17.40% in others, and 73.08% in small caps, with the highest allocation in capital goods at 11.43% and banks at 10.99%. The fund has also delivered strong recent performance, posting 25.88% gains compared to 7.91% by the benchmark in the last three years, and 18.67% over five years against 15.64% by the benchmark. The fund is managed by Alok Singh and is benchmarked against Nifty Smallcap 250 (TRI).
For investors sitting on 30-40% gains in mid and small caps, the focus should be on valuation and prospects rather than recent performance, as stated by TrustLine Holdings. The decision to hold, prune, or trim positions should be taken on a stock-specific basis, with primary emphasis on the valuation and prospects of the underlying business. Recent data from ETMutualFunds shows that the Nifty Smallcap 250 is expected to grow by around 27% in FY27 and 33% in FY28, providing support to the segment even after the strong rally. Investors should maintain a balanced exposure of around 55% in large caps, 23% in mid caps and 22% in small caps to capture stability as well as growth potential, with allocation decisions based on long-term strategy rather than chasing past returns. The fund has also demonstrated strong risk-adjusted performance with a Treynor ratio of 1.60 and alpha of 0.39 over the last three years, while the Sortino ratio stood at 0.49.
