SEBI's Small-Cap Advisory: Are The Markets Frothy

Retail investors and mutual funds have driven a remarkable surge in the value of Indian mid and small-cap stocks over the past six months. 

India’s market regulator is telling mutual funds to look out for investors in small and mid-cap plans because they're worried parts of the $4.5 trillion stock market are getting too excited. The Securities and Exchange Board of India (SEBI) has given suggestions like slowing down investments and protecting investors from sudden withdrawals. But it's up to the funds to decide what to do. They've got 21 days to figure it out.

“When everyone is excited, especially about companies that haven't done well in the past, we're not sure if it's going to last,” said Tej Shah, who manages investments at Marcellus Investment Managers in Mumbai.

Investors particularly the new retail investors have helped drive up the prices, even for companies that were doing badly before. 

WhatsApp groups sharing stock tips are getting popular. Rich individuals and mutual funds are joining in too. Small-cap stocks and mid-cap stocks in India have gotten a lot more valuable in the last six months because regular people and mutual funds are buying shares in companies that were struggling before. But now, some people are worried that parts of the market are getting too bubbly.

The MSCI India Small Cap Index went down by 1.1% on Thursday, following a 1.6% drop the day before. Small and mid-sized stocks have been leading the way in India's stock market boom over the past year. Funds focusing on these stocks got nearly 40% of the $19.5 billion of new money coming into the stock market in 2023.

Because small caps have fewer people trading them, new money can have a big impact on their prices. On average, the people who started the companies, called promoters, own 55% of the Nifty small-cap index, compared to 40% in the bigger index.

“When there's more money chasing fewer stocks, it can make stock prices go up for the wrong reasons,” said DP Singh, who helps manage money at SBI Funds Management Ltd.

Many fund managers are already taking steps to protect their investors. Kotak Asset Management Co. has put limits on how much new money can come into its small-cap fund through regular investment plans because the prices of some small companies are getting too high.

In January, SEBI’s Chairperson, Madhabi Puri Buch, said the regulator is checking to see if these funds can handle big drops in the stock market or if lots of people suddenly want their money back.

“Many funds might decide to stop taking big new investments in these parts of the stock market for a while,” said Abhilash Pagaria, an analyst at Nuvama Wealth Management Ltd. But regular monthly investments shouldn’t be affected.