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India’s smaller companies have earned another look after suffering through some two years of under-performance relative to their larger peers.
The divergence between the two groups is significant compared with longer-term historical correlations, according to Citigroup Inc. The MSCI India Mid-Cap Index has lost 17 per cent in the past two years, while the benchmark S&P BSE Sensex Index has gained more than 20 per cent.
With better risk-reward post under-performance, we would selectively look to add mid-caps, Citi analyst Surendra Goyal wrote in a note this week. Valuation discount of mid caps versus large caps is close to 10-year highs, highlighting the improved risk-reward and low expectations. In two years, mid-cap sentiment seems to have gone from extreme optimism to huge pessimism.
Companies across India - big and small - are grappling with a slowing economy amid waning consumption. Prime Minister Narendra Modi has announced a series of reforms to arrest the slide and attract investment, including an overhaul of controversial labour laws, aggressive cuts to corporate taxes, relaxation of foreign investor rules and the biggest privatization drive in more than a decade.
India’s economy is forecast to slow further to 6 per cent growth this year, following a deceleration in 2018, according to economists surveyed by Bloomberg .
One of the reasons to buy mid and small caps is the high return potential if investors can pick a winner, Goyal said. Of course, this is easier said than done. The analyst notes that only 2 per cent of small caps have become large caps over the past 10 years, while 20 per cent either have ceased to exist or are no longer listed.
The odds are a bit better for mid caps, with 15 per cent able to elevate to large-cap territory, but on the other hand almost two-thirds were downgraded to small caps. Top mid-cap picks from Citi include cement maker ACC Ltd., biotech Biocon Ltd. and L&T Finance Holdings Ltd.
Financials, health care, materials and industrials make up more than 70% of the MSCI mid-cap index. Less than a third of the 26 names in the gauge are in the green this year.
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