Yesterday, the AMFI published its monthly report for the month of September 2026, and one thing stood out which also drew a lot of media attention- the cumulative AUM under Small Cap and Mid Cap Mutual Fund Schemes is now respectively greater than the AUM under Large Cap Funds. Also, the monthly flow into such schemes is almost 5-10x larger than the money deployed by investors in Large Cap Funds.
Couple this with recent commentary by leading players which in effect states that the large cap indices, namely Nifty 50 or Nifty 100 may not be the true reflection of Indian stock markets and the real economy and thus, stock market performance is to be found in smaller companies. This also gets reflected in the dichotomy in stock performance by these indices- while Nifty 50 is down 12-13% from its all-timehighs, small and mid-cap indices are at near all-time highs and have also made fresh highs this year.
Thus, the new Gospel in the market is that one should forget large caps and buy small companies. We beg to differ!
To our understanding, this view is not a beacon of hope but a cry in desperation. The past two years have delivered zero to negative returns across categories and the industry realizes that the retailer religiously buying through the SIP may be losing patience. A widely referred meme on social media states that the five-year SIP returns in Nifty 50 are now less than the 5 year FD.
This is the ultimate challenge before the industry. SIP as a product have been popularized as a means of buying into future prosperity over the past 6-7 years and delivered decent returns until 2024-25 because of extreme low base during Covid years. Come 2026, with the interest rates inching upwards and consistent selling by the FII, the gospel of equities being the only asset class worth investing is staring at an uncertain future.
Large cap companies have historically had higher float and greater FII holdings and thus are more susceptible to relentless FII selling. Smaller companies, on the other hand are either too small for a meaningful FII holding or thanks to higher promoter holding has lower float which means small but sustained buying can deliver higher prices and thus, better stock performance.
Beginning this year, we began to realize that our markets are heading towards a downtrend for reasons listed out in our previous blogs. Increasingly, we have stronger conviction that the mid and small cap stocks are now in a territory where they will have to undergo a sharp price and a sustained time correction because valuations don’t grow to sky. The best performing stocks in favored sectors are now trading at valuations which does not make sense to us and are reminiscent of the valuations some of the then loved and now hated large caps were trading in 2018-19 period. The gospel then was to buy quality at any price and those who did have paid a heavy price and are now struggling to make sense of 5 to 7 years of zero returns.
Why we believe that the smaller companies may not be making a lot of returns from here are multi fold:
1. The Cost of Capital is inching upwards, globally and we have been repeating this ad nauseum for almost 9 months now. The RBI did raise rates in October and that led to Indian 10Y yields at closer to 7.4% as we speak. The last time our yields were at these levels, the repo rate was 6.5%, both in 2022-23 and 2018-19. In the prevailing global scenario, we believe that the terminal rates in current rate hiking scenario will be closer to 7% over the next 2 years and this isn’t a one-off hike. We also believe that the inflation across the world will be sticky and will not just vanish overnight, doesn’t matter what the US Treasury Secretary says.
The RBI has also come out all guns blazing to defend rupee beyond the 97 level to a Dollar while also trying to draw excess liquidity from the system, thus, raising the cost of borrowing which translates into higher bond yields. If it doesn’t do that, inflation will be a natural outcome.
2. Any supporter of the current regime will understand that the economic policy of this government is fixated on lower inflation. The BJP famously lost an election on onion prices in 1998 and since then, they are extremely wary of higher prices. So, at no point, will the finance ministry allow inflation to go beyond a certain level and the only way out is to keep liquidity conditions tight. The government, as Sanjeev Sanyal tweeted today is happy with 7% growth and 5-6% inflation rather than attempting 8% growth with 10% inflation.
3. Fiscal Prudence is also a hallmark of this regime. With major state elections around the corner, it is pragmatic to believe that there will be announcement of usual vote-catching schemes and to balance the budget, government capex will most likely take a hit. We have heard the ministers complaining about the higher urea prices globally and the subsidies the government is bearing. In no logical world, this government will keep up with the high capex figures lest it falls foul of fiscal prudence! This is also the reason why we do not subscribe to the idea of a LTCG/STT cut any time soon. If at all this happens, it will happen closer to the 2029 elections rather than in 2027.
4. Many smaller companies trading at extremely high valuations are a direct beneficiary of higher government capex and have large order books. Those who have been in this game long enough will appreciate that order books can shrink overnight on one policy decision and the multiple contraction which follows it is generally brutal. We recently have had some policy related moves in the Insurance space, and the market wasn’t forgiving at all!
5. Other companies which are currently favored have either the promoter selling equity or large QIPs being undertaken. In either way, excess supply will at some stage flood the markets and with numerous fresh issues and lock-in shares hitting the markets every month, it is only a matter of time that we see the stock returns disappoint investors.
To sum up:
Whenever something is a part of the consensus and making money feels easy, its time to be cautious. A couple of years ago, unlisted shares were a darling of the investors and when the IPO happened, a lot of disappointment followed. Many investors who bought in with the expectation of strong listing gains found that they are now sitting with 20-30% unrealized losses and a lock-in of a few months! Similarly, the PSU basket of 2021 has gone out of favor today along with the erstwhile quality stocks.
We hold the belief that the Indian stock market, especially the mid and small cap part will see diminished returns over the next three-to-five-year period and the current New Gospel will also fade away, sooner rather than later!
Disclaimer:
Caelis Ventures intends to launch its Portfolio Management Service after obtaining the required Certificate of Registration from the Securities and Exchange Board of India (SEBI). Currently, we do not manage third party funds nor do we offer investment advice to the public of any kind . Any or all activities of such nature will only be undertaken when and if we obtain the Securities and Exchange Board of India (SEBI) registration. Any information shared here on any other social media platform or in any form should not be construed as an advice or solicitation of any kind. At present, all our activities are strictly proprietary only. The directors, officers, and employees of Caelis Ventures do not receive any fee, commission, or remuneration related to such information.
