Mid and small cap funds likely to outperform large cap

The small and midcap category has also shown a remarkable recovery since the March 20 pandemic lows, says Vinit Sambre, Head-equities, DSP Mutual Fund. Sambre says new investors need to be very cautious in this volatile market. Edited Interview.The equity markets are still continuing the upward trend, despite the volatility. What is your outlook for the market in the near term?The equity markets are witnessing increasing volatility of late due to factors like rising US yields, high crude oil prices and talks of tapering. For corporate India, earnings estimates have seen upgrades but margins could be at risk due to rising input costs. Further, equity markets are trading at a market capitalisation to GDP ratio of 103% which is higher than its long term average of 77%. Given this backdrop, in the near term we expect markets to give up some gains after the spectacular rally which we have witnessed from the March ’20 lows.Small and mid-caps have staged a good recovery. How do you see the segments in terms of valuations and risk reward?The small and midcap category has also shown a remarkable recovery since the March 20 pandemic lows. As the economy grows and becomes more broad based with many more sectors participating in the recovery due to factors like rise in capex, improvement in real estate demand, improving rural health, focus on manufacturing through PLI scheme, it is also providing wider choices and raising confidence for a good long term outlook. In the short term though we would say the upsides may be lower due to high valuation in this space and the fact that we have also see some risks emerging as we observe the rally extending into low quality businesses.Many new investors have joined the party since January. What should be the return expectations from small and mid cap funds?The returns from equities over the long term tend to converge with earnings growth. Small and midcap companies, due to their low base, has the potential to outperform the earnings growth when compared to their large cap counterparts and hence possesses better ability to outperform over the long term.New investors who have joined the party since January need to exercise a lot of caution as they are investing at high valuations and the temptation to go down the quality chain to seek higher returns is very high. We would advise these investors to have a long term time horizon- of over 7-8 years and not to digress from their focus on quality. How should retail investors play this volatile market? What are the dos and don'ts?As mentioned earlier, the retail investor should exercise due caution and should avoid investing on tips thereby risking their hard earned money. Investors should avoid investing with the expectation of achieving quick gains from the market, as we believe that equity is a good asset class that rewards patient capital. There is a debate about passive and active mid cap funds in the market? Do you believe passive mid cap funds can be a hit in the Indian market?Going by the favourable long term outperformance track record of majority of the midcap funds, I would imagine the pace of shift to passive would be slower. The case of shift to passive mid cap funds would become stronger if the majority of midcap funds consistently start underperforming the index. Which are your preferred sectors in the current market?We prefer banking, Insurance, Cement, IT and sectors related to the agri market.

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