Indian Equity Markets at a Lifetime High! Which Market Cap Segment to Invest in Now?

July 13, 2023 Mutual Fund

India has thrived in a slow-growing global environment by providing an opportunity for macroeconomic growth that is sustainable. Markets have risen since April 2023 as a result of a steady macroeconomic outlook and low crude oil prices. The Q4 results for FY 2022-23 were likewise positive, demonstrating that demand was still gaining pace.

The Indian stock market saw a spectacular run in June that helped the NIFTY 50 and BSE Sensex to set record highs. As the month came to an end, the NIFTY 50 traded close to the 19,300 mark, and the S&P BSE Sensex crossed the 65,000 mark thanks to significant inflows from foreign institutional investors (FIIs), strong corporate balance sheets, moderating inflation, growth picking up, and expectations of a typical monsoon season, all of which bolstered the sentiment of market participants.

[Read: Sensex at All-time High: Is It Time to Sell Your Equity Mutual Funds?]

Since all indexes reached their lifetime highs in July 2023, the Indian stock market has remained strongly positive. In fact, on Friday of last week, small-cap and mid-cap indexes and the three major benchmark indices-the Nifty 50, S&P BSE Sensex, and Bank Nifty- climbed to a new peak. In Asian markets, Tokyo and Hong Kong quoted in the green, while Seoul and Shanghai were trading lower. The European stock markets are currently trading in the green.

It’s a fact that investing in equities through mutual funds is considered one of the best options. However, with markets hitting an all-time high, many mutual funds investors are now wondering if it is the right time to invest or if they should wait for correction.

Graph 1: YTD performance of NIFTY 50

*Past performance is not an indicator of future returns
Data as on July 12, 2023
(Source: ACE MF) 

The return of strong foreign inflows, the buoyancy in the global markets, improving macroeconomic fundamentals and the easing of inflation in India are the key drivers that have further boosted confidence in the Indian equities market. The U.S., where the market is resiliently backed by better-than-exected Q1 GDP growth of 2% and dropping weekly unemployment claims, is where the bullishness is receiving its global support. Despite positive news from domestic sources, the future of the markets may not be entirely bright due to foreign headwinds caused by the U.S. Fed’s indication of two sequential rate hikes and the ongoing conflict in Ukraine.

Moreover, talking about how expensive is the market right now, it is very difficult to make a statement about the state of the market in terms of whether it is expensive or cheap. However, if you look at the conventional yardstick, price-earnings ratio, and all other metrics on which the market is evaluated on its valuation, the market seems to be just about reasonably valued, it is not extremely expensive, companies are not trading at prices which looks unacceptable.

Having said that, the valuations have increased due to a quick run-up in the Indian equities markets. India is fetching a premium even on a 12-month forward P/E compared to other emerging economies and the world. The valuations are high for mid- and small-cap stocks as well. Earnings projections in India are anticipated to rise over the next two years on the domestic front. If there is too much dissatisfaction about slower economic growth due to increased commodity costs, notably high energy prices, which may result in possible profit downgrades, valuations could be harmed.

Will this rally continue, and how one should approach the equity market at it’s high? These are the questions that could arise in the mind of many investors.

Let us see how different market segments are performing under the equity market…

The Small-cap and Mid-cap indices have outperformed the larger benchmarks during the current quarter, lending strength to the trend of narrowing valuation differential. In the last three months, the Mid-cap mutual fund category as of June 2023 generated average returns of 17.4%, while the Small-cap mutual fund category generated average returns of 19.1%, driven by a sustained broad-based rally in the equity market. These two categories outperformed the Large-cap mutual fund category average of 13.6%.

*Past performance is not an indicator of future returns
Data as of July 12, 2023
(Source: ACE MF) 

Notably, both the Nifty Smallcap 250 and Nifty Midcap 150 indices are now trading at record highs. Investors poured money into these two sectors, encouraged by the rally. The Association of Mutual Funds in India (AMFI) recently released data showing that between March and May 2023, the Midcap fund category received inflows totalling Rs 5,116 crore, while the inflows in the Small-cap fund category stood at Rs 7,895 crore, significantly higher than most other sub-categories of diversified equity mutual funds.

[Read: Market at All-time High: Is This a Good Time to Invest in Mid Cap and Small Cap Mutual Funds?]

On the contrary, the Large-cap mutual fund category experienced the second consecutive month of net outflows. The cumulative outflows in the Large-cap mutual fund category for the first quarter of FY 2023-24 was at Rs 3,360 crore. So far in the current calendar year, the inflows in this segment have been among the lowest in diversified equity mutual funds. This comes at a time when the benchmark indices Nifty 50 and the S&P BSE Sensex are trading at their all-time high levels.

Markets are recording new highs each day, it’s scaling new peaks. But how expensive is the market right now? What should be your investment strategy? Let’s find out…

Moreover, talking about how expensive the market is right now, it is very difficult to make a statement about the state of the market in terms of whether it is expensive or cheap. However, if you look at the conventional yardstick, price-earnings ratio, and all other metrics on which the market is evaluated on its valuation, the market seems to be just about reasonably valued; it is not very expensive, and companies are not trading at prices which look unacceptable.

Now, should these market movements dictate your plan of action? When the market is driven by momentum, several stocks that aren’t fundamentally very strong also tend to rise. This situation isn’t specific to the month of July alone. Hence, investors must be cautious while investing and do the required analysis before making investment calls.

What should be the investor’s approach during a market high?

The things that will influence your path or the performance of your investments should be entirely within your control rather than being determined by the market. Therefore, you should build a strategy and have a plan that is in your power. It is incredibly difficult to resist this market since it moves so quickly every day that you always feel as though you missed out on something. However, one should make an investing plan and stick to it rather than being carried away by the current market high.

The year 2023 might be a successful year for Indian equities if the monsoons do not play spoilsport in response to the developing El Nino conditions that could result in drought and uneven rains that could drop agricultural production and inflate prices. Further, the possibility of global recession, a rise in inflation again, macroeconomic uncertainty and geopolitical tensions are some of the key risks. If these risks do materialise, Indian equities are unlikely to remain immune. Thus, it would be preferable to refrain from overly tilting the investing portfolio towards equities that swayed the market highs.

As mentioned earlier, looking at the all-time highs in the mid and small-cap segments, many investors are allocating their assets to this space in the equity market. In India, mid and small-cap segments are experiencing extensive activity, which is likely to continue. However, as we all know, the mid and small-cap market space is highly volatile and requires a long investment horizon to generate significant returns. Thus, investors may consider a strategic approach towards investment in these market segments in the equity market.

If you want to take advantage of the higher margin of safety and stability offered by large-caps and at the same time capitalise on the high growth opportunities of small and midcaps, it would be prudent to follow the ‘Core & Satellite Investment Strategy’.

Why Core & Satellite Investment Strategy is worthwhile for investors?

‘Core’ as the name suggests, is the crucial part of an investor’s portfolio. When making core investments, you normally stick to a well-diversified strategy and don’t take on any more risk than the total risk associated with that asset class. The core portfolio offers stability and is designed to help investors achieve significant long-term objectives like retirement or funding a child’s higher education.

‘Satellite’, in turn, is the tactical allocation whereby one takes a relatively higher risk in order to earn higher portfolio returns. It alludes to the strategic element that would assist in enhancing the portfolio’s total returns regardless of the market conditions.

The Core & Satellite investment strategy is time-tested and adopted by many successful equity investors across the world. It facilitates optimum allocation across investment styles, with an aim to gradually build wealth in the long run. By wisely structuring and timely reviewing the Core and Satellite portions and the holdings therein, you would be able to add stability to the equity mutual fund portfolio while strategically boosting your portfolio returns at the same time.

For instance, with the help of this strategy, an investor may allocate the funds across market caps. For example, the ‘Core’ holding could comprise around 65-70% of your equity mutual fund portfolio, consisting of mutual fund schemes that provide exposure to the large-cap universe. This comprises blue-chip stocks of companies which are leaders in their sectors and have seen multiple business cycles. You could also think about investing in index funds that follow the Nifty 50 and Nifty Next 50 benchmarks that provide equity market participation at a low cost, without any fund manager bias. Additionally, given that they are comparably less volatile and risky than equities, some investors may wish to include debt instruments in the core section of their portfolio.

Using active funds managed with a sound strategy and robust investment framework, investors may allocate 30 to 35% of their whole portfolio to the mid and small-cap category for the satellite allocation, which has the potential to exceed the benchmark. Other asset classes or sub-categories of equity mutual funds, such as gold, sector funds, overseas funds, etc., might also be included in the Satellite portion for diversity; some of these might be for very short periods of time for tactical market views. As a result, your Satellite allocation is distinct and frequently requires more study and analysis before investing.

This article first appeared on PersonalFN here