The Right Way To Choose Small-Cap And Mid-Cap Stocks

Despite steep underperformance by small-caps and mid-caps over the past couple of years there is a perception amongst investors that these categories are the ones with greater potential for returns. Yogesh Supekar details the steps that need to be taken in order to build a portfolio of small-caps and mid-caps while Karan Bhojwani throws light on the performance of the broader markets

- Karan Bhojwani

The derivatives market volumes reached record highs in 2019 and this is a testimonial to the fact that volatility is on the rise in global equity markets. Indeed, 2019 can be marked as a year of stirring announcements where the ‘to blow hot, blow cold’ comments from US President Donald Trump-induced heightened volatility in the global markets. Along with the increased volatility, what was noticed in Indian equities was the deep underperformance of small-caps and mid-caps in 2019. The underperformance was severe considering the fact that the small-caps and mid-caps underperformed even in 2018.

That makes it two years of solid underperformance by the broader markets. This polarised behavior of the market was never seen before by a majority of market participants. Come the second half of 2019, already a consensus was getting built about the valuation gap between the broader markets and the large-caps being at its widest and that the extreme relative under-performance of the broader markets would be reversed.

Clearly enough, the trend and along with it the sentiments have changed when it comes to small-cap and mid-cap investing. As we move further into 2020, there are ominous signs that the small-caps and mid-caps may more than catch up with large-caps. In such a market environment when the broader markets are expected to outperform, investors can be expected to build a portfolio of small-caps and mid-caps with a portfolio beta greater than 1.

Buying Small-Cap and Mid-Cap Stocks