India’s equity markets have seen a lot of volatility over the last year as a slowing economy and troubles in the shadow banking sector back home and rising geopolitical and trade tensions globally have made investors nervous. Even as the BSE Sensex and NSE Nifty 50 indices touched record highs, the small-cap and mid-cap stocks continued to decline, as investors rushed to the safety of a few quality large-cap stocks.
On Monday, the benchmark indices tanked near 2 per cent amid escalating tensions between US and Iran, that have fuelled a rally in crude oil and in turn raised fears of inflation surging in India.
The BSE Sensex tumbled 788 points to close at the 40,676.63 level, down 788 points or 1.9 per cent. The Nifty 50 closed near 234 points or 1.91 per cent lower to settle at 11,993.05 points.
To tide over such volatility, ICICI Prudential Mutual Fund, the country’s largest asset management house, is batting in favour of dynamic asset allocation schemes. Depending on the market conditions, investments made in these funds is moved between equity and debt securities. Fund managers typically invest anywhere between 30 per cent to over 70 per cent of the portion in equity, based on the prevailing market situation.
For investors seeking low risk, or for first-time investors who may not be keen to put their entire corpus into equity schemes, dynamic asset allocation funds offer an alternative. These funds typically have low volatility and have delivered reasonable returns of around 9 per cent over the last one year. In the current scenario, where a few stocks have risen a lot, but many others have underperformed, these funds could offer some respite for investors who are worried about the volatility.
“Through the last year, we have been telling people to invest in asset allocation and we start the year again going back to recommending asset allocation. We are not in a situation where equity is a dirt-cheap asset class where we can give a big buy call. We have this balance advantage model. It is not saying at this point of time that you go very substantially aggressively into equities,” said Sankaran Naren, chief investment officer at ICICI Prudential MF.
Over the past one year, select large-caps have rallied sharply as investors considered them safer investment bets amid the overall volatility. Between February 2018 to December 2019, the market capitalisation of the top ten stocks has surged 43 per cent. During the same time, the market cap of stocks between 251-500 has declined by 23 per cent and the market cap of stocks above 500 has more than halved.
As small-cap valuations have corrected sharply over the last two years, Naren says investors could start looking at increasing allocations to this category. However, small-caps as a category is riskier, and one has to do a lot of research on the companies' before picking up small-caps. Given that small-caps can underperform for a longer time, they not suitable for people, who have a shorter time horizon.
“For two years, the small-caps have underperformed 50 per cent to the large caps. After this kind of an underperformance, clearly we move to a situation where today we really like small caps, much more than any other area. Small-caps will remain a high risk. But, if I take a 4-5 year kind of view, we clearly are in a situation where small-caps looks interesting,” said Naren.
Currently, we see an extreme polarisation in the valuation of select large-caps over the small and mid-caps. For instance, even as the BSE Sensex surged 13 per cent over the past one year, BSE Smallcap index is down 6 per cent. Naren, says the polarisation is unlikely to last long and will go away over 3-5 years.
