There could be a resurgence in large-cap stocks; should you invest in large-cap mutual fund?
The mid-cap and small-cap segments of the market have held sway for a while now. Large caps have merely plodded along. For year-to-date returns in 2023, the Nifty 50 has gained 5%, even as the Nifty Midcap 150 and Nifty Smallcap 250 indices have soared 23% and 27%, respectively. Given the relative valuations and emerging market scenario, experts reckon that conditions could be ripe for large caps to take over the performance charts over the next year.The recent mania in the mid- and small-cap space sent stock prices to dizzy heights, often without the earnings tagging along. The correction in the broader segments may give the impression that the froth in the space has receded. However, this is far from reality. Even as several mid- and smallcap stocks have seen sharp cuts, the correction is modest against the meaty rise witnessed in their stock prices over the past six-seven months.
It has barely made a dent in the lofty valuations for some of the high-flying stocks in this basket. “We do not find value in most mid- and small-cap stocks in our coverage universe, given the extent of re-rating in multiples seen in the past 9-12 months despite weakening business models and eroding business moats,” observe analysts at Kotak Institutional Equities.
Large-cap risk-reward appears favourable
The recent market correction has barely made a dent in mid and small caps.
The divergent return profile has led to compression in the historical premium of large-cap stocks relative to mid and small caps. Even as the bellwether Nifty 50 index trades at 20.45 times trailing 12-month earnings, the Nifty Midcap 150 is valued at 25 PE and the Nifty Smallcap 250 at 23.5 times. Amid the broader market rally, the contribution of mid and small caps to the overall market cap has risen sharply over the past year.
According to data from Capitaline, the top 100 companies by market cap now account for just 65% of the total market cap, compared to 74% in January 2020. Meanwhile, their current share in the total profit pool stands at 70%. Comparatively, the combined market cap of mid and small cap comprises 25% of the total universe, compared to 22% in January 2020. The current share of mid and small caps in the corporate profit pool is 23%.
“In our view, large-cap stocks offer better reward-risk balance, given the more reasonable valuations, versus the lofty valuations of most mid- and small-cap stocks,” contend the analysts at Kotak Institutional Equities. The brokerage recently removed SRF from the model large-cap portfolio and allocated the weight to HDFC Bank, ICICI Bank and Reliance Industries.
Bigger firms cede space to broader market
Large caps’ share of market value has declined even as they dominate profit pool.
Analysts at Motilal Oswal expect the sectoral rotation to continue based on valuations. “There are significant divergences in the performance of large caps versus mid/small caps and across sectors. We believe that in the midst of volatility over the next couple of quarters, sectoral rotation could be a more important driver than the general market uptrend.” According to Motilal Oswal analysts, the sectors that are still trading at reasonable valuations include banking, auto, healthcare and select large-cap IT stocks. Their top large-cap ideas include ICICI Bank, ITC, Bajaj Finance, L&T, HCL Tech, M&M, Titan, Avenue Supermarts, Ultratech Cement, M&M, BoB, and Zomato.
Apart from the comfort of valuations, large caps could benefit from the ongoing pullback in the market, owing mostly to the flight of foreign capital on the escalation of geopolitical tensions and other global worries. Once the global risk appetite improves, foreign investors are likely to flock back to the Indian markets. These flows will mostly be pumped into the large-cap basket.
This is not to suggest that the mid- and small-cap story is over. In a growing economy like India, the big, long-term wealth will continue to be created in mid- and small-cap space. However, given the current dynamics, experts reckon the probability is higher that large caps will outperform the broader market in the coming year. The investors who are underweight in large caps may consider rejigging their allocation to take advantage of this shift. It is critical that you continue allocating to mid and small caps. Deepak Jasani, Head of Retail Research, HDFC Securities, believes that the Nifty could do better than small and mid caps over some months or quarters, but on an overall basis, the broader market may still do well. “Smalland mid-cap space is where one can hope to gain alpha (excess return) and, hence, outperformance in individual stocks can happen through the year,” he says. Jasani also feels that the valuations of small-cap and mid-cap indices seem higher as these indices include some loss-making companies.
Interestingly, among actively managed equity funds, the past year has seen the highest proportion of large-cap funds outperforming their benchmarks. Most mid-cap and smallcap funds, on the other hand, have lagged their respective indices, even as the broader market saw a sharp rally. This is in sharp contrast to the previous few years, when large-cap equity funds underperformed woefully. If large caps start outperforming, it will be worth monitoring if large-cap equity funds keep pace with the benchmark or if they start underperforming again.
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This story originally appeared on: India Times - Author:Faqs of Insurances
