Is today the right time to increase equity exposure?

Have the markets bottomed out? Or will there be more troubles ahead?

These questions have probably crossed your mind at least once if you are looking to take advantage of the recovery from the current equity market crash.

Markets have become highly unpredictable now with the impact of coronavirus, on the world economy, getting graver with every passing day indicating more troubled times ahead.

Its spread has affected large, mid, and small caps alike. While larger companies may be better poised to absorb this economic shock, smaller companies may be at high risk as their fortunes are closely tied to the economic growth.

In January 2020, I had mentioned that this year could be the best for investing in mid and small cap funds with a long term view as they are likely to become major beneficiaries of the expected economic recovery.

And despite sharp correction in indices and a gloomy environment, I reiterate it.

Here is why…

The S&P BSE Midcap index is down from its peak level of 18247.6 in January 2018 to 11881.6 now, while S&P BSE Smallcap index is down from 20047 to 11095.2.

This gives the mid cap index an upside potential of ~54% and a whopping ~81% to the small cap index if they get back to their past peak levels over the next few years.

Thus, the sharp decline has made the small and mid caps even more attractive. Though be forewarned that volatility is likely to continue in the near future.

Graph: Mid and small caps’ mighty fall from the peak

Base taken as 10,000
Data as on March 16, 2020
(Source: ACE MF, PesonalFN Research)

What would drive the growth?

At the beginning of the year, there were strong hopes of economic recovery, though the unforeseen event of coronavirus has put it back in the doldrums. The Health and Safety restriction on social gatherings, travel bans, disruption of supply chain for manufacturing in some sectors, etc. has led to the drop in economic activity.

A lot now depends on how quickly the spread of virus is contained. The RBI has said that it is closely monitoring the situation and is ready to take necessary measures for market stability.

Once the conditions improve, markets are likely to bounce back strongly.

The silver lining lies in the valuations. P/E of midcaps is now far lower than the levels recorded in 2017 and 2018. This offers a decent value buying opportunity at this juncture with a reasonable margin of safety.

So if you have a long term horizon and an appetite for high risk, nothing should stop you from taking exposure to mid and small caps. But picking quality individual stocks with strong fundamentals and high growth potential can be a difficult task. Opt to invest in actively managed and worthy mutual funds that can generate wealth for you.

Table: Mid and small cap funds outshine the index

Category YTD (Absolute %)
Midcap funds
Best performing fund -9.75
Worst performing fund -20.78
Category average -13.92
S&P BSE Midcap – TRI -20.57
Smallcap funds
Best performing fund -3.09
Worst performing fund -21.30
Category average -14.20
S&P BSE Smallcap – TRI -19.01

Data as on March 16, 2020
(Source: ACE MF, PesonalFN Research)

Even as mid and small cap index continued to sink, most mid cap funds with an outperformance rate of 96.2% and small cap funds with an outperformance rate of 85.7% have managed to contain the downside.

The top performing mid cap fund delivered an alpha of approximately 11 percentage points over the S&P BSE Midcap index, whereas the top performing small cap fund generated an alpha of around 16 percentage points over the S&P BSE Smallcap index.

But has this outperformance come at reasonable risk?

The true essence of alpha is to generate ‘extra return without taking extra risk’. And quite a few well managed funds have the ability to generate alpha for investors, at a reasonable risk. These may be an optimum choice to gradually add up your equity exposure to, especially in conditions like now.

Even if further downside remains, staggering your investment via  SIP will help you average out your investment cost and aid in reducing the

This article first appeared on PersonalFN here


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