Small Cap and Midcap Re-classification yard Stick needs to be Changed...

If the yardstick of measurement needs a change whom will you change the effort or the measurement yard? Do we are all having problems revising our yardsticks for stronger growth or we are happy with traditional measurement ways? Will you change your client’s early retirement plan due to the wrong yardstick or you will ask the big giants to relook to change the yardstick? 

 A huge number of new analysts and mostly many IFAs have suddenly due to the blessing of YouTube and some blind followers become Midcap and small-cap analysts.  SEBI's cautious approach is bound to go ahead as we have seen previously burning fingers. We remember that in 2018 we witnessed a similar cautious approach where many MF schemes stopped taking inflows. Well of them kept inflows coming and they burnt their fingers.

We might all have forgotten that last time some brokering company came up with Midcap and Small cap valuation reports and they said it's time to exit but we all know what returns we achieved. The problem of today is the classification limitations and the same is not restricted to MF but across all equity products. 

The problem with the whole understanding of the Midcap and Small cap segment is that we are getting carried away too much on the Index performance whereas underlying stock valuations are low or rather cheap. What we are missing out on is that India’s market cap is currently the 5th largest globally (US $4.5trn) but India’s weight in global indices is still low at 1.6% (10th rank). This number will improve as India breaches the 5 trillion GDP economy.

• We saw strong YoY earnings growth in the 3rd quarter results in auto, lending financials (ex-SBI), industrials, energy, cement, pharma, capital markets, and metal sectors. Now these sectors are the economic sectors where India is focusing to be manufacturing a manufacturing-independent country. 
• The PLI is also attached to the same segment driving growth. Now the midcap and small cap are the ones who are going to benefit from the same. Or do you want only pharma, IT and FMCG to perform for your client portfolio and let India struggle with GDP growth of 5 trillion?
•  If the Nifty is going to be at 25000 levels in FY-25 then where do you find Midcap and Small caps to reach and who will support this rally of the Indian stock market. Why SEBI should rework on classifications and if they don’t do this will have a problem for investing in the coming days as India reaches and  crosses the 5 trillion GDP mark.
• At the aggregate level, the capacity utilisation (CU) in the manufacturing sector increased to 74.0 per cent in Q2:2023-24 from 73.6 per cent in the previous quarter.
• The IIP-Manufacturing (Quarterly Average) is also on the rise followed by De-trended Quarterly IIP-Manufacturing space converting from negative to positive.

•  If you look at the order book numbers in detail you will get clarity that we have a lot to work on and a lot of earnings to be taken into books in real terms rather than based on expectations.
•  Overall Gross Fixed Capital Formation has risen to 34% of the GDP in FY23, levels last seen in 2013. Capital Expenditure (capex) substantially augments the economy's productive capacity and exerts a more profound influence on long-term growth and productivity in contrast to revenue expenditure.
•  As more capacity utilization and economic growth drivers play their dice the MSME segment will benefit the most which will impact the price of the Midcap and small-cap stocks.
•  Now deep diving into the capex of Indian corporates we find that non-financial companies witnessed a strong capex growth of 36.5% YoY during FY23, much higher than the 22.6% YoY growth recorded in FY22.
•   Further, it has been found that the aggregate capex undertaken by Indian non-financial firms in 2023 surpassed pre-pandemic levels for the first time, with 3.3% above the pre-pandemic baseline of 2019
•  The government has spent Rs 5.46 lakh crore, around 54.7% of the budgeted capex target of Rs 10 lakh crore for FY24, as of October-end, according to data from the Controller General of Accounts.
•  Now with the interest rate outlook getting lower in FY25 and with Mr. Modi coming back again in his 3^rd term, is bound to increase confidence among the market investors and MSMEs.
•  Looking at the derivative numbers we find that participation in the derivatives market is on the rise in India with the derivatives-to-cash ratio at 400x as of July 2023, the highest in the world.  Thanks to YouTubers, full-time stock traders and 15cr new demat account holders which is still galloping like a horse.
•  Volumes in Nifty futures have jumped by 44 per cent since July 2023, however, the volumes in the Nifty Midcap Select index have jumped much higher, also owing to the low base.
• The number of demat accounts opened with the two depositories – the Central Depository Services (CDSL) and the National Securities Depository (NSDL) -- rose 28.7 per cent in the past 12 months, from 108.1 million to 139.2 million. About 4.1 million demat accounts were added in December 2023, making it the highest-ever monthly addition.
• This new breed of investors has been investing for a long time, and they don’t come with any legacy of Harshad Mehta, Ketan Parekh etc.  This new-age client wants clean government and progressive economic policies for the growth of their career and life.
•  As salaries will grow investing appetite will grow more and with smartphones in the world and free information on the other hand the investing and risk-taking ability has changed.

The biggest proof of the pudding is that despite Ukraine Russia war and historical new highs of US Federal rate hikes the market scaled to new highs in many countries.  The historical predictions have already been challenged hence one needs to understand the world's behavioural aspect of investments.

 This time the risk part is that fund inflows have too much concentration on the limited count of quality stocks. What is the need of the hour is that we need a complete re-evaluation of Midcap and Small definitions and some further bifurcation which will benefit the Fund managers and investors.  

Now many people have suddenly jumped into large-cap investment options and simply diluted the goal-based, risk profile-based financial planning and the Investment document decided mutually with the client while doing asset allocation investment in mid and small-cap.

People have become crazy in accentuating too much on the segment where they have forgotten that MF is just not alone in doing investments in the segment. We have underlying index funds, Insurance, Direct Equities, PMS and AIF products doing investments in the same ocean.  This is the place where the voice gets strengthened and SEBI needs to ACT fast for another reclassification to help the investors and investments.

Where we are going wrong is that instead of categorising stocks by their market capitalisation, the emphasis should be on the growth potential and fundamental strengths of the companies. I did not hear a single IFA neither wealth manager nor any top honchos of the financial Industry asking for changes in the mechanism of the measurement yardstick rather than asking everyone to be careful. Rebalance but don’t exit and since reinvestment is another challenge. Reevaluate your goals and focus on early closures of goals.  Will you ask your client to exit Midcap and small caps and become zero but what will you do with Large and Midcap, Flexi cap and Multicap Midcap allocations?