Nifty Smallcap 100 index tumbles another 2.5%, down over 6% in March so far; here’s why

Small-cap stocks faced selling pressure for the second consecutive day on Tuesday, with the Nifty SmallCap 100 index plunging by 2.5% during today's intraday trade to 15,012 points, following a 2% decline in the previous trading session.

Concerns have been raised by analysts regarding the prolonged rally in small-cap stocks in recent months, leading to inflated valuations. Madhabi Puri Buch, the chairperson of the Securities and Exchange Board of India (SEBI), highlighted these concerns on Monday, emphasising the stretched valuations observed in both small- and mid-cap stocks. This warning contributed to a sharp drop in small-cap stocks during the previous trading session.

Also Read: Sebi chief flags risk of bubble in stock market

Furthermore, apart from recent actions against non-banking financial companies (NBFCs), the Enforcement Directorate's ongoing investigation into whether proceeds from the Mahadev betting case were routed into the small-cap and SME segments of the market also added to Monday's market downturn.

The market regulator, late last month, asked mutual fund houses to put in place a framework to safeguard the interest of investors who invested in small and mid-cap funds amid the froth building up in the segments. This came against the backdrop of huge flow in the small and mid-cap schemes of mutual funds over the past few quarters. 

Also Read: 15 multibagger small-cap stocks tumbled between 15% and 30% from 52-week highs; check full list

Buch said that by March 15, SEBI will make available a disclosure format on stress testing for small- and mid-cap funds. Investors will benefit from knowing how many days the funds would need to liquidate their underlying portfolios in the event of unfavourable market conditions.

Buch explained that the stress tests would determine how many days MFs would need to liquidate the investors’ portfolios if prices fell and volumes jumped. The regulator also wants small and medium enterprises (SMEs) preparing to go public to disclose risk factors in greater detail to potential investors.

In the calendar year 2023, small-cap and mid-cap schemes accounted for 40% of the total net inflows into active equity schemes, receiving ₹64,000 crore of total inflows of ₹1.6 trillion. 

Also Read: Sebi may review rule for funds targeting overheated small caps

Meanwhile, the recent correction in small-cap stocks has caused many previously high-performing stocks to retreat significantly, with some trading 10% to 35% below their 52-week highs. 

Consequently, the Nifty SmallCap 100 index has declined by 6% so far this month, marking the most substantial monthly drop since June 2022.

Dr V K Vijayakumar, Chief Investment Strategist, Geojit Financial Services, said, " The correction is likely to continue since the valuations are even now excessive. The regulator SEBI has sent a clear message about the frothy valuations in the small-cap segment and, therefore, regulatory actions are likely, going forward." 

"There can be redemptions from small-cap funds, adding to the downside. Quality large caps will bounce back after a correction, but small caps are unlikely to bounce back in the near term. PSE stocks that have run up too much too fast also are likely to face selling pressure," he added.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before taking any investment decisions.