Mutual funds bought 505 smallcap stocks in the March crash. Two weeks later, they’re winning big

While retail investors were fleeing, India’s mutual funds were buying. While the Nifty Smallcap 250 index rose 10% in March, fund managers from across the country’s asset management industry quietly turned net buyers into 505 smallcap stocks in a bet that has paid handsomely as the index has gained 13% so far in April.

As per Prime Database estimates, mutual funds in March collected a collective Rs. Urban Co. was the single largest acquisition by value, with a stock purchase of Rs 862 crore. The next nine names on the buy list read like a conviction portfolio built for recovery trade – Manappuram Finance (Rs 431 crore), Amber Enterprises India (Rs 399 crore), Jain Resource Recycling (Rs 294 crore), RBL Bank (Rs 292 crore), Aster DM Healthcare (Rs 230 crore), Finance 230 crore rupees. Aether Energy (Rs 211 crore), Sona BLW Precision Forging (Rs 203 crore), and Dr. Lal Pathlabs (Rs. 202 crore).

Beyond the top ten, the breadth of purchases was staggering. Fund managers also accumulated positions in NetWeb Technologies, Hindustan Copper, Swan Defence, PTC Industries, Zen Technologies, Inox Wind, Tata Technologies, Tata Chemicals, SJS Enterprises, DCB Bank and Azad Engineering – indicating financial sectors across the defence, health and industrial sectors. Call instead of separate stock-picking.

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Funds that call it

In late January, ICICI Prudential Mutual Fund indirectly signaled opportunities in the small-cap end of the market when it resumed subscription to its small-cap fund. Later, Tata Small Cap Fund also reopened lumpsum investments.

“We were cautious in the small cap segment and closed the consolidation window in June 2023, as earnings expectations were running ahead of fundamentals and valuations were elevated,” said Chandraprakash Padiyar, senior fund manager at Tata Asset Management. “However, over the past two years, market volatility and global geopolitical factors have led to a meaningful moderation in earnings expectations and improvement in valuations. At current levels, we believe valuations are more reasonable and the risk-reward has become favorable.”

Padiyar added that the fund has undergone a significant internal restructuring in the last 15-18 months, with about 75-80% of the portfolio rejigged and the top 30 companies now holding more than 70% – a concentration around high conviction ideas with strong earnings visibility.

Now the broader case for smallcaps

The conviction is not limited to Tata. Vinay Pahria, CIO of PGIM India Mutual Fund, argued that the March selloff, which he attributed to a confluence of oil shocks, capital outflows, currency pressures, AI-related growth concerns and growth downgrades, favored the market by removing excess valuations.

“Many of these are transient and will resolve themselves with the passage of time,” Pahria said, adding that large caps and small caps are now trading very close to their long-term valuation averages. He flagged midcaps as a segment that still has moderately rich valuations and therefore under-picked. “Now is a good time to increase allocation to Indian equities.”

Paharia was particularly constructive on quality growth businesses, where he argued that both valuation and earnings growth are aligned for long-term investors, a combination that rarely presents itself outside of a sharp market correction.

Axis Mutual Fund’s valuation was more measured but directionally consistent. In its market note, the fund house acknowledged that valuations have “adjusted meaningfully”, with large, mid and smallcap stocks falling and excesses built up over the past year falling. However, he cautioned that the picture was not uniformly rosy – select cyclical, industrial and financial names offered attractive entry points, while large parts of the consumption and investment-forward sectors continued to trade at elevated multiples.

“So the current environment is better characterized by valuation volatility than uniformly attractive valuations,” Axis said, reminding investors that March’s buying opportunity rewards selection, not a blanket smallcap bet.