Tighten your seatbelt

Even as small- and mid-cap funds touch new highs, selection, time horizon & quality will prevail in the long run

Unless you have been living under a rock, you’d know that small and mid caps are in the midst of a riotous party. Even Jay Gatsby would have been proud. As of July 31, the small-cap index has gunned out 21.66 per cent returns, followed by mid-caps’ 18.75 per cent. In contrast, the Sensex – a proxy for the large caps – has delivered a comparatively middling 10.34 per cent. But does that mean we should jump aboard the gravy train now?

Frothy valuations

Since small caps have been sitting pretty on an express train, we studied the P/E ratios of mid- and small-cap funds to determine the valuations. The graph titled ‘Weighted-average portfolio P/E’ shows the average P/E of the category over the last five years. Though some distance from the peak, the P/E ratios are hovering in higher ranges. Simply put, this segment is now available at a premium price.

Not surprisingly, fund managers advise caution but aren’t overly worried. Shreyas Devalkar, the head of equity at Axis Mutual Fund, told us: “With markets at all-time highs, valuations are mostly elevated. Hence, valuation risk does come into play here. Investors can consider these (funds) from a long-term perspective. In the past, the market has seen corrections and sideway movements after sharp rallies. But sticking to good quality companies with growth potential has resulted in investors generating returns in the long term.”

Maintain composure