Are mid-cap and small-cap funds and stocks overvalued? Know what you can do as the dream run continues

financialexpress.com:

The dream run of mid-cap and small-cap funds and indices in the last six months has caught the attention of investors and critics alike. While investors are enjoying the extraordinary run, critics have been cautioning about the steep rise in valuations. Some have even likened the meteoric rise of mid and small-cap segments to an irrational exuberance. However, both sides have worthy points to justify their stand at this phenomenal turn of events over the last six months, writes Gopal Kavalireddi, Vice President – Research at FYERS, in a report. The following are the edited excerpts from the report:

As per AMFI’s August data, equity mutual funds witnessed higher flows for the fifth consecutive month. Of the Rs 20,245 crore of equity inflows, Rs 6777 crore (33%) net inflow was into mid and small-caps. Moreover, since the start of FY24, the Nifty 50 index has delivered a 14.2% return compared to the over 36% return from Nifty midcap indices and more than 40% return from the Nifty small-cap indices (See chart below).

While the shorter-term scenario looks like investors are chasing momentum and infusing more capital into mid and small-cap stocks, a larger time frame reveals a different perspective.

After three years of underperformance between 2017-2020, FY21 and FY22 were very rewarding for market participants, with mid and small-cap indices outperforming Nifty 50 by a considerable margin. However, the trend changed in FY23, as the Nifty 50 and Nifty midcap indices delivered flat returns, and the Nifty small-cap 100 delivered a negative return of 13.8 per cent.

Recognizing the undervaluation in mid and small caps in light of the improving economic environment, vigilant investors moved their allocation from large caps to mid