Systematic Investment Plans (SIPs) have been a favored investment strategy for Indian investors seeking long-term wealth creation. However, S. Naren, the Chief Investment Officer of ICICI Prudential AMC, has issued a cautionary note about the current state of mid-cap and small-cap mutual funds.
He warns that these segments are significantly overvalued, and investors may face disappointing returns if they continue their SIPs in these funds without understanding the risks.
The Overvaluation of Mid & Small-Cap Funds:
S. Naren highlights that mid-cap and small-cap stocks are currently trading at a median Price-to-Earnings (P/E) ratio of 43, which he describes as “absurd” when compared to historical trends.
To put this into perspective, let’s look at an example:
- Case 1: Large-Cap Fund – If a large-cap fund trades at a P/E ratio of 20, it implies that investors are paying ₹20 for every ₹1 of earnings generated by the company.
- Case 2: Small-Cap Fund – If a small-cap fund trades at a P/E ratio of 43, investors are paying ₹43 for every ₹1 of earnings, which indicates a much higher valuation compared to large-cap stocks.
Historically, such high valuations have often led to lower returns in the medium term. Investors who continue to pour money into mid and small-cap funds via SIPs might face lackluster returns in the future if market corrections occur.
Are SIPs at Risk?
SIPs are designed to work well over the long term by averaging out market volatility. However, Naren warns that those who started their SIPs after 2023 in mid-cap and small-cap funds might not achieve the expected returns.
For example, if an investor started an SIP in 2019 when valuations were lower, they would have accumulated units at a cheaper price. On the other hand, an investor starting in 2024 would be buying units at expensive valuations, which could result in lower long-term returns unless they stay invested for at least 20 years.
Should You Shift to Large-Caps & Flexi-Caps?
Given the high valuations in the mid and small-cap space, Naren advises investors to consider shifting their SIPs to large-cap, flexi-cap, and hybrid funds. These categories currently offer better value and stability.
- Large-cap funds invest in well-established companies with strong fundamentals, making them less volatile compared to mid and small-cap stocks.
- Flexi-cap funds allow fund managers to allocate investments dynamically across large, mid, and small-cap stocks based on market conditions.
- Hybrid funds provide a mix of equity and debt investments, reducing overall risk.
The Importance of Diversification:
Naren strongly emphasizes diversification as a strategy to mitigate risks. Instead of concentrating all investments in mid and small-cap funds, investors should diversify across various asset classes such as:
- Equity: Large-cap and flexi-cap funds
- Debt: Bonds and fixed-income instruments
- Real Estate: Real estate investment trusts (REITs)
- Global Stocks: Exposure to international markets
- Gold & Silver: Precious metals as a hedge against inflation
For example, an investor who allocated 60% in equities, 20% in debt, and 20% in gold/silver would have a more balanced portfolio than someone who is entirely invested in mid and small-cap stocks.
Profit Booking: Why It’s Necessary:
Naren suggests that investors should protect the gains made in the past five years by periodically booking profits. This means selling a portion of their investments when markets are high and reinvesting when valuations are more reasonable.
For instance, an investor who invested ₹5 lakh in small-cap funds in 2019 might have seen their investment grow to ₹12 lakh by 2024. Instead of continuing to invest at peak valuations, they could book profits and reallocate to large-cap or hybrid funds.
The Market Debate: Fear vs. Reality
Naren’s remarks have sparked debate within the mutual fund industry. Some experts agree with his concerns about overvaluation, while others believe that his warnings are overly cautious.
- Supporters argue that markets operate in cycles, and the high valuations of mid and small-cap stocks indicate a potential correction in the near future.
- Critics believe that Indian markets still have growth potential and that investors should remain committed to their SIPs.
Conclusion: What Should Investors Do?
If you are an SIP investor, here are some key takeaways from Naren’s warning:
✔ Assess your portfolio: Check if you are overly invested in mid and small-cap funds.
✔ Consider shifting SIPs: Move towards large-cap, flexi-cap, or hybrid funds.
✔ Diversify your investments: Don’t put all your money in one asset class.
✔ Book profits periodically: Protect gains from the past few years.
✔ Think long-term: If you continue in small and mid-cap SIPs, ensure a 15-20 year horizon.
While SIPs remain a powerful wealth-building tool, it is crucial to be mindful of market cycles and valuations. Being proactive in managing your investments can help you achieve sustainable and consistent returns over time.
What’s your take on this? Are you planning to adjust your SIP strategy?
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Note: Please do not take this as any recommendation, to trade or invest. This is just for reference, to make you understand more about the current SIP situation and its importance, under no circumstances intended to be used or considered as financial or investment advice, a recommendation or an offer to sell, or a solicitation of any offer to buy any securities or other form of financial asset.
Please do your own research and make investment. Moneycontain will not be responsible for any of your losses at all. The point made is for educational purpose only. All investments are subject to risks, which should be considered prior to making any investments.
Please note that past performance is not indicative of future results. It’s advisable to consult with a financial advisor before making investment decisions.
