Sebi move will result in re-rating of small and mid-sized companies: Madhusudan Kela


By Nikunj Dalmia

The regulator with this move has told the mutual funds industry that be true to your characteristic, says the market veteran

Am I right in saying that this in a sense is early Diwali at a time like this when we all are struggling for good news for a midcap stock picker like you?
I do not think this is only limited to the next two months. This is more of a structural move like the Amfi classification of largecap, midcap and smallcap stocks. The rules were very clear for the largecap companies and for the smallcap companies. And now, very timely, Sebi has defined that multi-cap funds must truly reflect that characteristic. Just after this news, I saw a lot of multi-cap funds have invested maybe up to 90-95% into largecap companies which is defined by the regulator. It is a fantastic move. It would not have come at a more proper time when India, in general, is struggling and if it is implemented and if the category of multi-cap remains where it is, this will lead to significant re-rating of small and mid-sized companies for sure.

Would you argue that this is only a liquidity move and a short-term booster shot? The small and midcap companies’ stock prices may go higher but what happens to business fundamentals? Why do you think that this is going to change fundamentals?
Who is there to say that there is no value or there are no gems in small and mid-sized companies? There are a lot of companies which have a tremendous amount of value and I have been investing money in mid-sized companies so I can tell you with confidence that there is a lot of value in that space. And such a move will help recognise the value of these enterprises. Let us not forget that India is a very enterprising country. When entrepreneurs who are running unlisted companies realise that they can actually get true value for their asset in a listed format, a lot of beautiful companies will start to get listed because there will be valuation. What has happened in the last two years is that the markets got so polarised that these are only 25-40 companies wherein 90% or 80% of the mutual fund asset is being parked in. This move will help unlock value in a lot of small and mid-sized companies. This will help broaden up the whole market and this will help a lot of companies which are in the unlisted domain, lot of new businesses which could not get listed because there will be valuation in the stock market.

We saw a very big midcap bull market between 2013-2014 to 2018 before they peaked out. If a bull market indeed has to start in small and midcap stocks, how will it be different from the last bull market?
It would be because mutual funds are going to invest this money. We believe that the mutual fund managers have experience so the money is going to be in their hands. It won’t be the case that just because it is a smallcap company or a mid-sized company, it will qualify to be in the portfolio of a mutual fund scheme. What will happen even within the smallcap space and the midcap space is that the companies which have got a very strong business model, very high standard of corporate governance are the ones that will qualify for investment by the mutual fund industry. So, this will be different than what has happened in the past.

Do you think this also is going to fix a lot of underperformance challenge the mutual fund industry has been facing largely because of concentration in few mega stocks like Reliance or HDFC Bank?

There will be differentiation within the portfolios and within the performance for people who have the skill to identify good companies in the mid and small size segment. This is because till now if you bought a smallcap or a midcap company there were not many takers in the size of that smallcap and midcap basket.

If the overall mutual fund industry is roughly Rs 10 lakh crores, I am just giving that number, the smallcap basket was only Rs 40,000 crore and maybe mid-sized companies were another Rs 40,000-50,000 crore. So, only 10% of the overall money was invested in small and mid-sized funds.

All the companies which were there in this space were not getting takers. This move will ensure that there will be Rs 25,000 crore of additional buying in smallcap space. Sebi has given roughly six months time to align the portfolio. So in that timeframe, a lot of companies which have got hidden value will get truly recognised. And people who want to only invest in largecap companies will move some amount of allocation from multi-cap funds to largecap funds. And people who want to only be in smallcap space, they can move some amount of allocation from multi-cap companies to smallcap companies.

What happens to largecap stocks now? Can they get into time-wise and price wise correction?

Yes, to some extent there will be a correction because this is not new money which is coming. So, if there is a Rs 25000 crore buying that would happen in smallcap companies, there will be corresponding selling from the largecaps because this is not new money which is coming in the market. This is the money which is going to get circulated. Now, it remains to be seen how much money actually will remain in multi-cap funds but I am sure there will be selling in largecap names and there will be buying to that extent into small and midcap names. This is a brilliant move from the regulator to broad base the market like India where there are 2,000 listed companies and we cannot have a polarised market of only 10 or 15 or 20 stocks.

Given the number of demat accounts that have opened, the appetite for mid and smallcap stocks is there and not just from the mutual fund industry. If the mid and smallcap space gets rerated, a lot of individual investors may start walking on the path of small and midcap stocks now. What’s your view?
This is not a two or a three-month move. This is more of a structural imbalance which is there in the marketplace, wherein a lot of the largecap companies are trading at a phenomenal valuation. I am not saying they are not doing a good job or they are not good companies but the difference between the valuation of small and mid-size companies vis-a-vis large-sized companies has become very wide and this kind of a move to some extent will help to bridge the gap.

Suppose you buy a small cement company which is trading at $40 and some mutual fund investor decides to buy that at $40 valuation, and that company goes from $40 to $80. Then it will still be cheaper than $200 at which the large company is trading but all the other companies which are trading at $30- $40 will get rerated. Now all of them will not get bought by the mutual fund schemes but there will no longer be that kind of difference between one smallcap and another. The overall market will get rerated in the small and mid-size segment.

Do you not think that in a bad market or when a market correction kicks in, some of these stocks can also suffer equally?
They will suffer and to that extent, investors will have a choice. When the market corrected in 2008, even the largest companies corrected. We have seen that phase when this corona issue came in March. When the market will correct, everything will correct and the impact on the small and mid-sized companies will be to that extent larger but that is for the investors to decide whether they want to take that risk or not, whether they want to invest into multicap funds which have this risk. Or conversely, if you were in 2018-kind of a situation where there was a bull run which was going into small and mid-sized companies and if you were in a multicap fund, which invested 95% of your money into largecaps, then you have also missed the rally. The regulator with this move has told the mutual funds industry that be true to your characteristic. If you are saying multicap, at least, let it get reflected. Now, it is upon the investor to choose whether he wants to take the risk of being invested into small and midsize companies. If he does not want to take the risk, then he can always move to largecap funds.


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