In 2017, midcaps were in the news for the right reasons having delivered more than 40 per cent average returns. Now again, midcaps are in the news; but this time for the wrong reasons such as excessive price volatility engineered by hyper-speculative activity and corporate governance issues like auditor resignations.
In March this year SEBI, in consultation with NSE and BSE, decided to introduce a new regulation called Additional Surveillance Mechanism (ASM) for curbing excessive price volatility in mid-caps. The market regulator and the exchanges had clarified that this need not be interpreted as an action against the companies concerned. It was emphasised that these measures were being introduced as a measure of abundant precaution to protect investors.
Rationale of ASMs
Demonetisation accelerated the process of financialisation of savings in India. Financial assets, particularly stocks and mutual funds, became the favoured asset classes. Retail investors, particularly, the first-time retail investors, rushed to midcaps and small caps lured by stories of spectacular returns. The stories are indeed true in the long run. But in the short run, this segment can be a veritable minefield destroying investor wealth.
Huge money flowing into midcap and small cap stocks and
mid and small cap funds had pushed up their valuations beyond justification, often, into bubble territory. Sane words came from many experts and signals from the market itself on these excessive valuations.
Some microcap funds stopped taking money in their funds. These were signals to investors to be cautious. But, the words of
wisdom fell on deaf ears. Hyper speculation with leveraged funds only increased. As always, many market operators and some ‘experts’ played ball.
SEBI and the exchanges acted in time by introducing ASMs and further by increasing the number of stocks on June 9. Under the provisions of ASMs, 5 per cent circuit, trade-to-trade, and 100 per cent upfront margin are applied on stocks to curb excessive speculation. Additional measures like progressive reduction in trading in the stocks are possible. The additional margins impacted the mid-caps, in particular and the market in general, severely. On June 5, in the BSE, across categories, 573 stocks hit lower circuits, out of which 63 were ‘A’ group stocks, while 400 stocks fell to 52-week lows.
These are steps in the right direction. But these measures alone are insufficient to curb the excesses. Excesses are part of the stock market. Stock markets tend to over-react, both on the upside and the downside. That’s the nature of the beast. Many uninformed investors will lose money in low-grade stocks. The ASMs will certainly help mitigate the problem. It is better for investors to invest in midcaps and small caps through SIPs in mutual funds, unless they have the skill in identifying quality small and mid-caps.