(Bloomberg) — A correction in India’s small-cap stocks portends souring risk appetite on the broader market, which is now an underperformer in Asia Pacific.
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An index of small-cap stocks has lost more than $40 billion in market value in less than two weeks after authorities flagged risks of overheating and guided funds to limit purchases. The selloff deepened on Wednesday, with gauges of small- and mid-cap stocks plunging more than 4% each.
As sentiment weakens, investors are pulling money out of richly valued larger shares as well. The MSCI India Index is now lagging MSCI’s Asia-Pacific Index for a second straight month. Some investors anticipate losses will deepen.
“The regulatory actions against small cap stocks are testimony to the valuation froth in India. India could continue to underperform Asia going into the national elections in the next few weeks and amid the chip rally in other markets in the region,” said Nitin Chanduka, a strategist at Bloomberg Intelligence.
The Securities and Exchange Board of India has been concerned about large flows into small- and mid-cap stocks amid an outsized rally in the riskiest area of the nation’s $4.5 trillion market over the past year. It asked funds to come up with measures to moderate inflows into related plans and safeguard investors from sudden redemptions.
“It may not be appropriate to allow bubbles to keep building because when they burst, they impact investors adversely,” Chairwoman Madhabi Puri Buch said earlier this week. Sebi is open to allowing money managers to hold more large-cap stocks in their small-cap portfolio to manage risk, she said.
Buch further said the regulator has observed “patterns of price manipulation” in new listings taking place on platforms for tiny companies.
In light of the regulator’s remarks, ICICI Prudential Asset Management Co. on Tuesday said it temporarily halted lump-sum deposits in its mid and small-cap funds starting Thursday. Last month, Kotak Asset imposed limits on flows on recurring plans in its small-cap fund, citing the sharp surge in this segment that has led to “valuation distortions” in some cases.
The S&P BSE Small Cap Index is down more than 12% from an all-time high reached earlier this year. Smaller stocks led the record-breaking rally in the Indian equity market in the past year, forcing foreign funds to look beyond the typical large cap names.
“This space was too hot and the correction may not be completed in a hurry,” said Porinju Veliyath, founder and portfolio manager at Equity Intelligence Pvt. Ltd. “There is still a lot of froth in many pockets,” he said, adding that the slump may provide investors an entry point into quality stocks.
(Updates throughout.)
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