Friday, February 23, 2024

Who is to blame for your smallcap losses?

The important question is this: If all these gurus were warning about the stock market having become irrational how come money continued to pour into the frothiest of segments i.e., smallcaps?

I have shared some data before, and I am reproducing it here again:

(Contramoney)

View Full Image

(Contramoney)

As is clear, a large chunk of the money was going into the frothiest segments of the market. (And this is just mutual fund data; imagine the amount of money flowing into smallcap stocks directly!).

So, who’s to blame for all the losses suffered in the last few days?

Let’s start with the easy pick. The talking heads on TV.

I think it’s clear that the general tone of the talking heads was super bullish these past few months. Yes, there were exceptions who called out frothiness in valuations, but they were just that. Exceptions.

It’s true India’s future is bright as ever. And I too believe the Indian economy will do very well over the coming years, and possibly decades too. But that does not mean you can buy any stock at any price and expect to get away with it! The only thing that can save you is a greater fool theory here, but that’s a foolish idea in the first place.

The fact is that valuations had lost touch with reality, especially in the smallcap space. Sooner or later, they were going to revert to them mean. Perhaps this is that moment. Perhaps not. But the fact is reversion to the mean was bound to happen. And the talking heads on TV did not call it out loud enough!

The other segment that we can pick on is the individual/boutique/new money management firms that exclusively focused on smallcap stocks. You can also club some over-enthusiastic finfluencers here. A lot of them peddled the idea that there is no other space like smallcap stocks that can deliver equally big returns.

It was almost made out to be a given that “in the long run smallcaps do better”. Just buy them and hold on. That’s just hogwash. There are so many moving parts in this statement, that it likely to cause a lot of damage to anyone who believes in it blindly.

Take a look at this 15-yr chart (source: TradingView.com):

(Contramoney)

View Full Image

(Contramoney)

You can clearly see the clear outperformance of the smallcap and midcap indices is just a 3-year-old phenomenon. Keep that in mind.

Now, take a look at this same chart, but for a 10-year period.

(Contramoney)

View Full Image

(Contramoney)

Here you will notice the outperformance of smallcaps and midcaps is a lot more pronounced.

Why so? You see, the starting point matters. You need to invest in these stocks when few others are. That’s when you make potentially big returns.

But if you are buying when all around you are buying too, then, well, wait for 15 years and perhaps you will beat the Sensex, but then again, not by enough (for the risk you took by investing in unknown companies). Worst case, you will lose money as you may not have the patience to stick it out for such a long period of time.

Next in line must be the investment advisors who are closest to your money in a manner of speaking.

The mutual fund data clearly suggests that a many advisors kept egging on investors to increase exposure to the smallcaps and other frothy spaces even as the market took off, kind of irrationally.

This may be a good time to evaluate if your advisor is working for you or for his commission.

I also believe part of the blame lies with the mutual fund managers. While some did close their smallcap funds to lumpsum investments, more could have done so. This could have served as a bigger signal to the market that something was clearly off.

The fact is most fund managers did not close their funds to new money…and this new money kept chasing the limited number of smallcap stocks…and which effectively created the situation we are in.

Finally, a large part of the blame resides with the investor i.e., us. We tend to get carried away in every bull market…buy into any and every bull market story with the hope of making a quick buck.

I had shared a solution to prevent this from happening. Plan your investments around financial goals based on real life needs. And then stick to that plan.

A carefully planned asset allocation will ensure you always have a fair idea of what to do with your money. And in case you do go wrong, the diversification that is built into any good plan, will ensure you don’t jeopardise your entire future because of one mistake.

Now, even as I write this, the markets have sold off. But no one knows, least of all I, on what will happen tomorrow.

Perhaps the markets will turn around and hit new highs. Perhaps smallcaps will rally like never before. No one knows!

I hope in such a situation you will not feel vindicated but instead thank your stars that you have an opportunity to course correct without much pain.

And in case the markets continue to fall, make the course correction anyway. However painful it is. That’s perhaps the right thing to do.

Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477.

You should always consult your personal investment advisor/wealth manager before making any decisions.

#blame #smallcap #losses

Related Articles

LEAVE A REPLY

Please enter your comment!
Please enter your name here

Latest Articles