Midcap and Smallcap shares witnessed intense selling pressure on February 28, with marquee indices representing these market segments plunging by nearly 2% each.
The sharp intra-day correction eroded over ₹3.5 lakh crore of investor wealth. Regulatory directives regarding mutual fund exposure sparked the rout, along with some profit booking after the stellar run this space has seen.
The BSE Midcap index slipped 2.03% or 827 points to close at 40,036 levels. The BSE Smallcap index also recorded a 2.11% or 1,001 point decline, ending the session at 46,385. This marked their worst single-day slide since February 2024.
Large Cap Stocks Provide Cushion
Even as mid and smallcap names bore the brunt of the fall, large cap stocks provided some comfort. Marquee names like Reliance Industries and HDFC Bank logged only marginal declines of 0.7% and 1% respectively. Automaker Maruti Suzuki also recorded a minor 0.3% dip amid the market slide.
This divergence highlights investors’ faith in large cap stocks despite the volatility. Due to their strong balance sheets, reputed large companies managed to weather the storm as compared to their mid and small peers.
Reasons Behind the Midcap and Smallcap Crash
SEBI Regulations Regarding Mutual Fund Exposure
Earlier this week, the market regulator expressed reservations regarding the significant fund flows mutual funds were witnessing in their mid and smallcap offerings.
Alarmed at the signs of possible overheating and stretched valuations, SEBI has directed fund houses to rebalance their portfolios.
The aim is to moderate exposure and inflows into the midcap and smallcap space. This directive sparked concerns that returns could take a hit if fund investments decline.
So investors rushed for the exits, creating panic selling in this pocket of the market.
Concerns Over Rising Valuations
Analysts have sounded caution about the frothy valuations mid and smallcap stocks have been trading at due to disproportionate flows.
The trailing price-to-earnings ratio for mid and smallcap indices had risen to over 35-36x compared to large cap Nifty’s close to 29x.
While earnings potential may support higher multiples, the sustainability was questionable.
SEBI’s latest regulations provided a reality check regarding the overenthusiasm among investors. Concerns of the rally outpacing fundamentals came back to the forefront.
Investor Sentiment Turns Cautious
Besides the SEBI directive, overall investor sentiment also turned negative. Key global markets including Wall Street traded lower as concerns over rising coronavirus cases gripped investors.
Closer home, traders likely opted for profit-booking as well after the scintillating returns from mid and smallcap stocks over the past year.
With valuations rich and regulatory concerns on the rise, traders rushed to pocket profits amidst the volatile conditions.
Key indices representing the midcap and smallcap segment had surged over 20-30% each in the last 1 year period. So some moderation in risk appetite was overdue as per analysts.
Insights Into Portfolio Rebalancing By Fund Managers
With SEBI mandating mutual funds to relook exposure to the mid and smallcap space, how are fund managers responding? Here are some updates:
“We are proactively analyzing our portfolio composition. The aim is to balance risk and enhance cushion for downside protection” said Vivek Menon of a leading fund house.
“But we continue to hold faith in the long term growth potential of select midsized companies we have invested in,” he added.
Another fund manager spoke about evaluating locked-in shares and considering a staged exit to book profits. With valuations stretched, funds are also unlikely to consider new investments at current prices. However, they continue to scour for opportunities to buy on significant dips.
As fund rebalancing takes effect in the coming weeks, it remains to be seen whether foreign investors step in to fill the void. But given the expensive valuations, FPI inflows may also slow down. Retail investors need to brace for some uncertainty in the interim.
Also read: Nvidia’s Blockbuster Q4 Earnings