Small-, mid-caps are India’s best bet, but equity supply is capping the index: Chris Wood

According to fresh market updates, India’s small- and mid-cap stocks stay the most interesting part of the market, offering stronger earnings expansion and access to a pool of entrepreneurial young firms that is increasingly being overlooked elsewhere in the world, according to Jefferies’ global equity strategist Chris Wood.

“The small mid-cap sector in India is the most interesting part of the market,” Wood stated in an exclusive interview with Moneycontrol.

India’s small-cap opportunity stands out at a time when market participants in many other markets are increasingly concentrating on large firms, encouraged by the expansion of indexing and passive investing.

“In many markets in the world, the small-cap sector is being ignored. People are investing more and more just in the big caps,” Wood stated. “Whereas in India, it's the opposite.”

The attraction, he stated, is not just the size of the universe but the quality of the expansion opportunities.

“You've got a lot of entrepreneurial talent. You've got a lot of interesting young, small firms,” Wood stated. “The small mid-cap sector is the best area. It's got the best earnings expansion.”

Large caps lose some of their appeal

Wood stated the large-cap segment no longer offers the same expansion profile that it did during some of India's strongest structural expansion phases.

Indian private-sector banks, for example, were “very exciting stories” from the late 1990s through 2020, he stated.

“There are no disastrous stories today, but the expansion profile is just not as good as it used to be,” Wood stated.

For domestic market participants investing in indian indian rupee terms, that makes it particularly important not to allocate exclusively to large caps.

“If you're investing in India, particularly if you're a domestic investor and you're indian rupee-based, it makes a lot of sense not to allocate only to the big caps,” he stated.

Foreign market participants are looking beyond the index

Foreign ownership of Indian mid- and small-cap firms has additionally been rising, suggesting that the broader market is attracting increasing attention from global market participants.

Wood sees this as a positive trend, although the size of global funds creates a natural constraint.

“The bigger the fund, if you're a very big fund, you can't really trade in small caps. It's just a question of the size of the portfolio,” he stated.

Equity supply is capping the index

While Wood stays constructive on the breadth of India's market, he sees a different problem at the headline index level.

Whenever sentiment improves, the market is met by a sharp gain in equity supply, he stated.

India has a “very healthy capital market” with robust domestic mutual-fund inflows that have remained resilient, particularly through SIP schemes. But firms are additionally willing to mobilize large amounts of equity.

“So while that's a very vibrant capital market, it means from an index level that equity issuance is capping the index,” Wood stated.

There was a big gain in supply last month, he stated, with the effect particularly visible at the large-cap level.

“That's having the practical effect of capping the index,” Wood stated.

Private capex offers a fresh positive

The mood among market participants at the Jefferies India conference is consequently balanced rather than euphoric, Wood stated.

“The mood is not euphoric, but it's not gripped by fear,” he stated.

The more encouraging development, he stated, is that firms are finally beginning to invest.

Government capex rose substantially during the second Modi administration, with the government effectively waiting for the private sector to take up the baton.

“The government sector has been saying, when it's a relay race, when is the private sector going to take up the baton?” Wood stated. He stated there is now evidence that firms are beginning to invest, and that credit expansion stays firm.

“So we are now beginning to see that evidence,” he stated. “That's probably the most positive thing, actually.”