Mutual funds focused on small-caps have emerged as the winner with a net inflow of close to Rs 11,000 crore in April-June quarter, as fund managers struggle to create alpha in the large-cap space, and the trend is expected to continue for some time.
On the other hand, large-cap space, which is yet to pick up momentum, witnessed an outflow of Rs 3,360 crore during the quarter under review, data from the Association of Mutual Funds in India (Amfi) showed.
Apart from the June quarter, small-cap funds logged an inflow of Rs 6,932 crore in three months that ended in March.
"The strong rally witnessed in the mid and small-cap indices in the last few months, and the fact that it is becoming difficult to create alpha in the large-cap space can be the reasons for the huge inflows into smallcap funds" Himanshu Kohli, co-founder, Client Associates, said.
The huge inflows into these funds have made fund managers more cautious in their stock selection as the valuations have become stretched, he added.
"The performance of small-cap stocks has been exceptional in recent months.
"An explanation for this may lie primarily in the valuation gap between small-cap companies and large-cap companies.
"This always happens when markets become expensive but fund flow chases stocks.
"During such markets, fund managers seek out value or pockets of opportunity that are available at a lower end of the radar," Mukesh Kochar, national head-wealth at AUM Capital Market, said.
In addition, investors are preferring small cap funds due to their higher growth potential at almost similar risk levels as midcap, Feroze Azeez, Deputy CEO of Anand Rathi Wealth, said.
The small-cap category in the mutual fund space has given impressive returns with a compound annual growth rate (CAGR) of 30-37 per cent for one year, 40-44 per cent for three years, and 18-21 per cent for five years.
Over the last five years, the small-cap universe has almost doubled from 8,580 crore in 2017 to 16,400 crore currently.
Moreover, the increase in the market cap of small-cap companies has also lowered the risk associated with small-cap stocks such as illiquidity and higher volatility.
The inflow has pushed the assets under management of small-cap mutual funds up by 28 per cent to Rs 1.7 lakh crore at the end of June from Rs 1.33 lakh crore in March-end.
In terms of sector, auto & ancillaries, capital goods, and IT are the most preferred sectors by small-cap mutual funds with a cumulative exposure of 23 per cent of the overall asset base.
In addition to small-cap mutual funds, multi-asset allocation funds have also gained popularity among retail and high-net-worth investors in recent years.
Going forward, AUM Capital Market's Kochar said that the inflow trend in small-cap funds may continue for some time to come.
However, there are some valuation concerns, but liquidity is chasing the long-term India story.
Despite small cap funds as a category that seems attractive, Anand Rathi's Azeez suggested that an investor may explore funds in this segment up to 30 per cent in their portfolio and 50 per cent allocation in large cap at a portfolio level.
