After several years of strong performance by mid- and small-cap stocks, large-cap funds are beginning to look more attractive for investors putting fresh money to work, according to DSP Mutual Fund’s latest Netra report.
The report highlights a sharp gap between the two segments. Small- and mid-cap stocks have significantly outperformed large caps in the current cycle. Historically, however, such periods of strong outperformance have not lasted indefinitely. During market downturns, small- and mid-caps have tended to give back much of the additional gains they made during bull markets. The report therefore argues that investors should focus on the margin of safety, rather than chase recent returns.
Valuations also favour large caps at the moment. The Nifty 50 was trading at a trailing price-to-earnings (P/E) ratio of 19.26 times at the end of September, below its long-term median of 20.9 times. Its price-to-book (P/B) ratio stood at 2.75 times, compared with a historical median of 3.5 times. The report describes large-cap valuations as “fair/cheap”.
The picture is different for mid- and small-cap stocks. The Nifty Midcap 150 was trading at 27.6 times P/E and 4.11 times P/B, while the Nifty Smallcap 250 was at 33 times P/E and 3.4 times P/B. The report describes small-cap valuations as “still stretched”.
This does not mean investors should exit small- or mid-cap funds. Rather, the report suggests being more selective. For investors already holding these funds, the recent rally may have increased their exposure to these segments, making portfolio rebalancing worth considering.
Also read: Sensex, Nifty in correction mode: Should you stay invested, increase SIPs or wait for the bottom?
For those investing fresh money, “large caps may offer a better risk-reward trade-off than chasing stocks that have already delivered strong returns,” stated the report. For small- and mid-cap exposure, investors may be better served by continuing through the SIP route rather than making a large lump-sum allocation based on recent performance.
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