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Play safe in small-caps even though the valuations seem attractive

Given their high volatility, conservative investors must limit exposure to 5-10% of equity portfolio

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Two developments have taken place within the small-cap space. One, these funds have, on average, run up 22.8 per cent over the past three months, outperforming their mid- (15.5 per cent) and large-cap (10 per cent) peers. Two, SBI Mutual Fund has announced that its Small Cap Fund will only accept money via the systematic investment plan (SIP) route, and not lump-sum investments. This has led to speculation that the category may have become overheated.

Valuations not exorbitant yet: The market rally since March has been driven by liquidity, which has lifted all boats, including small-caps. “During 2018 and 2019, small-caps were beaten down more drastically than large-caps. After the March downturn, their valuations were very attractive. Hence, when money started flowing in, some part went into small-caps,” says Arun Kumar, head of research, FundsIndia. He believes small-caps can rally further if economic recovery materialises and earnings improve.

This space is not overheated yet. “We have not reached the overheated valuations of 2017, if you go by the price-to-book value. The SmallCap index has not even touched its previous peak of January 2018,” says Kumar.

Restricting inflows a positive step: The closure of SBI Small Cap Fund to lump-sum investments does not signal that valuations have become overheated, as was the case when fund houses took similar action in 2017.

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“The fund manager may be finding it difficult to manage fund size while sticking to his mandate,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India. The small-cap space suffers from capacity constraints.

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First Published: Fri, October 23 2020. 19:16 IST