The strong outperformance of mid-caps over their large-cap pears that has been conspicuous since the past two years and continues to sustain in CY2017 as well, has pushed mid-cap valuations to their multi year highs.
Robust flows, both foreign (FII inflows of US$9bn YTD into Indian equities) and domestic (DII inflows of US$4bn YTD into Indian equities), have been a key factor in pushing large-cap market valuations higher to above +1standard deviation above mean. On forward PE basis, the Indian mid-caps are now more expensive than their large-cap pears– a first in over past 10 years (Ref. figure below).
Indian mid-cap focused mutual funds also continue to see significant AUM growth (+14% QoQ in 1QFY18). FIIs have also participated aggressively by incrementally making portfolio allocations to bottom of the 100-500 of the BSE-500 index during FY17.
One year forward PE of NIFTY & NIFTY Mid-Cap index.
Source: Citi Research, Bloomberg
In terms of earnings growth, Indian mid-cap universe has directionally tracked their large-cap peers, albeit with considerably higher volatility. Going forward, Citi analysts expect earnings growth to revive for the mid-cap universe, aided by a lower base of the past few years and also improvement in some operating parameters. Consequently, they expect some acceleration in EBIDTA and PAT growth in FY18 for the mid-cap universe. However a significant part of this accelerated earnings growth already seems priced into the valuations.
Hence, with market valuations above +1SD above mean and mid-caps even more expensive, it appears more important than ever to be prudent and selective in your portfolio allocations. Investors should carefully monitor & review their investment portfolios in order to reduce risks by portfolio diversification.