A sharp correction in small-cap stocks in India has led to a souring of risk appetite on the broader market. The Indian market, once viewed as a multi-year rally, is underperforming in Asia Pacific after authorities warned of overheating risks and guided funds to limit purchases. Small-cap stocks have lost more than $80 billion in market value in less than two weeks, causing a selloff and deepening the decline of gauges of small- and mid-cap stocks by over 4% each. This decline has also affected sentiment towards larger shares which are richly valued. The MSCI India Index is now lagging behind MSCI’s Asia Pacific index for a second consecutive month, with markets such as Taiwan and South Korea gaining preference due to their exposure to chip shares and the artificial-intelligence boom.
The Securities and Exchange Board of India (SEBI) has concerns about large inflows into small- and mid-cap stocks amidst the outsized rally in the riskiest area of the country’s $4.3 trillion market over the past year. To moderate inflows into related plans and safeguard investors from sudden redemptions, SEBI asked funds to come up with measures. SEBI has warned against the impact on investors caused by allowing bubbles to keep building and has expressed openness to allowing money managers to hold more large-cap stocks in their small-cap portfolio to manage risk.
SEBI’s Chairwoman, Madhabi Puri Buch, has stated that the regulator has observed patterns of price manipulation in new listings of platforms for small companies. This has affected new debuts in India, with three recent initial public offerings declining as much as 16% during their first trading days compared to an average gain of 20% this year until Wednesday. In light of these remarks, ICICI Prudential Asset Management and Kotak Asset have implemented measures to halt or limit inflows into their small- and mid-cap funds.
The S&P BSE Small Cap Index has declined more than 12% from its all-time high reached earlier this year. Despite this, some investors see this decline as an opportunity, as market participants overall remain bullish on Indian equities. Domestic institutional investors, including mutual funds and insurance companies, have invested a record $1.1 billion into local shares on Wednesday, according to exchange data. The rally in small-cap stocks had forced foreign funds to look beyond large-cap names but this correction indicates a potential downside for the market. According to Porinju Veliyath, founder and portfolio manager at Equity Intelligence, the current correction may not be completed swiftly as there is still froth in certain areas. However, this slump could provide investors with an entry point into quality stocks.
