‘We are looking for new ideas in sectors that will benefit from reforms’

Sohini Andani, Fund Manager, SBI Mutual Fund, reckons that there are still value picks to be had from among the universe of small- and mid-cap stocks. Excerpts:

Given the recent wild swings in

mid- and small-cap stocks, have investments in funds tracking these stocks turned riskier?

Volatility in the performance of mid- and small-cap companies has always been higher than in large-cap companies, given the vulnerability in their performance.

Their financial performance depends rather more on the external environment. Any movement in currency values and in the availability and cost of capital also impacts their fortunes.

This apart, volatility in the prices of raw materials and commodities takes a toll on them disproportionately more than they do on large-cap companies because small- and mid-cap companies typically do not have the financial strength to negotiate a better deal. Hence, investing in these companies is always riskier as compared to putting money in large-cap companies at any point of time.

The expectation of high growth prospects with a revival in economic activity has pushed up the valuation of mid-cap stocks of late.

However, the risk in financial performance of mid- and small- cap funds has increased their volatility.

With economic growth still not gaining traction, do you expect a major fall in mid-cap stocks?

It is difficult to make generalisations about a particular trend across a broad basket of stocks in different sectors. Given the past performance (in this space), investors have built up high expectations. I believe there will be a meaningful correction in the stocks of companies that fail to meet investor expectation by a huge margin.

What are the prospects of mid-cap companies’ financial performance in the context of the implementation of the Goods and Services Tax (GST), which benefits organised players and large-cap companies?

I believe that GST will benefit both large- and small-cap companies, though the scale of benefits could vary. GST benefits for companies should start flowing in the medium to long term as they gain market share from the unorganised sector.

In the short term, however, there could be issues surrounding growth for corporates that depend on their preparedness and that of their vendors.

One has to really wait and watch to see how fast they manage to adapt to the new tax reform and execute GST-compliant trades. So there could be some revenue loss in the short term compared to large companies, which are better prepared in implementing GST across the board.

After the recent run-up in the valuations of mid-cap stocks, are there still enough investment opportunities in this space?

In general, investment opportunities have reduced compared to a couple of years ago due to the significant run-up in the valuation of mid-cap stocks. Fund managers are forced to look for new ideas in sectors that will benefit from the government’s reforms. There are still opportunities in select sectors where stock prices have not rallied yet. I believe there are always some opportunities in the neglected sectors.

Which are the sectors in the mid-cap space that are likely to benefit from government policies?

The recent policies announced by the government are mainly aimed at ramping up infrastructure, be it investments in roads or railways.

The focus on providing housing for all is also a significant development, which will benefit real estate companies.

The manufacturing sector should benefit from the government’s measures to incentivise higher indigenisation in the defence manufacturing sector.

It will promote domestic manufacturing and provide employment opportunities. On the whole, I think the reforms initiated by the government will benefit companies in the infrastructure and construction space, besides cement and industrial companies.

Will Sebi’s classification of large-, mid- and small-cap stocks restrict mutual funds’ ability to generate alpha?

It is too early to comment on Sebi’s classification of stocks as the guidelines are yet to be finalised.

However, if the investment universe for mid-cap stocks is curtailed, it might restrict the ability of mutual fund managers to generate alpha in the way they did earlier.

Does the cost of funding deter mid- and small-cap companies’ growth?

These companies generally require upfront investments, and their revenue generation is back-ended.

They are affected by high cost of funding in the initial stages. However, buoyant capital markets do provide growth capital, though the cost of capital could be high.

What are the factors that will aid mid-cap companies’ growth from

here on?

There are many factors which should support growth of mid-cap companies. In general, consumer demand across sectors will be boosted by growth in personal income. Easy credit availability, the pick-up in exports, spending on infrastructure and low interest rates also provide the right platform for small-size companies’ growth.

The pick-up in industrial activity reflected in IIP (index for industrial production) growth is another important factor that can aid the growth of mid-cap companies.

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