Should you book profits in small-cap funds?
No denying the fact that every investor dreams about doubling their money in a span of one year. In the initial two months of the year 2020, only one fund delivered double-digit returns while just 50 per cent of the funds gave positive returns. The COVID-19 pandemic breakout led Nifty Small-Cap 250 Total Returns Index (TRI) tanked close to 38 per cent. Only a few investors had the guts to invest in small-cap funds. And, it is those investors, who have been rewarded handsomely. This is because if we look at the performance of small-cap funds in the past one year, then there is not a single fund that has delivered single-digit or negative returns. Not just that, the lowest returns generated by any small-cap fund was not less than 67 per cent. However, after looking at the stunning performance of the small-cap stocks or funds, people are planning to invest in them.
In the last one-year, Nifty Small-Cap 250 TRI gained around 125 per cent. On the other hand, small-cap funds on average delivered 91.21 per cent in the same period. In the calendar year (CY) 2018 and CY 2019, on average, the small-cap funds' category witnessed a decline of 18.62 per cent and 1.51 per cent, respectively. Now the question is whether or not one should book profits in small-cap funds? We shall find out the same in this article. So, stay tuned!
Valuation
Looking at the valuation would help us to get an idea of whether the small-cap funds have reached their peak or have some steam left in them. As the economy is still struggling with the impact of the pandemic, it is quite difficult to judge the valuations of small-caps based on their price-to-earnings (P/E) and price-to-book (P/B) ratios. If we look at the current P/B ratio of Nifty Small-Cap 250 TRI, then it stands at 2.97 when compared with the 10-year average P/B of 1.77.
The above graph clearly shows that on the valuation front, this might look quite stretched. However, what we believe is that there is some steam left in the small-cap space. This is because still, we can see the Reserve Bank of India (RBI) holding its accommodative stance to support economic growth. Further, when the economy would improve, it might prove to be quite beneficial for the overall equity markets. Therefore, we would suggest holding on to your investments in small-cap funds. Secondly, if you are approaching your financial goals, then we would suggest you to exit your investments in small-caps and divert them to debt funds.