India Capital Growth (IGC ) has explained that the Indian regulator’s recent steps to curb surging domestic investor inflows to the small and mid-cap space has not hurt the prospects of its holdings, but knocked the shares from a premium to a discount.

Fund manager Gaurav Narain told Citywire that while small and medium-sized companies had been the main driver behind India’s strong three-year returns, a recent six-month rally in the sector was a result of retail investors flocking to low quality and ‘narrative’ stocks, forcing the Securities and Exchange Board of India to stop what it saw as a bubble.

Last month, the regulator talked retail investors out of further buying by warning the market that 90% of active traders in derivatives had lost money and almost half of retail investors sold out of companies with a week of their flotations.

It asked mutual funds to increase the disclosure levels in their small and mid-cap savings schemes by carrying out a monthly stress test on liquidity, which involved calculating how long it would take to liquidate half the portfolio, Narain said.

Simultaneously, the Central Bank of India raised fears of money being diverted to stock markets through unsecured small ticket loans – or systematic investment plans (SIP), the main vehicle of retail investment – and raised the capital adequacy requirements for banks lending unsecured loans.

‘The intention of this is preventive. There is already some impact as several mutual funds have stopped accepting lump sum flows into small and mid-cap schemes, though they continue to accept the SIP inflows,’ Narain (pictured below) said.

The ensuing selloff means shares in the £141m investment company slumped 22% in the first three weeks of March, falling from the point of issuing shares at a premium rating to trailing 15% below net asset value. The discount has since narrowed to 8%.

The board chaired by Elisabeth Scott emphasised the fund’s focus on high quality companies with predictable growth, meaning it did not participate in the rally, with its shareholder returns of 19% trailing the S&P BSE Midcap benchmark’s 27% surge. 

She told Citywire that on a trip to India last month, the board met several portfolio companies and government officials. She said it was clear there was confidence in the economic momentum for this year and next with banks reporting low numbers of non-performing loans.

‘The IGC portfolio came down from recent levels as the market fell – in the short-term good or bad stocks fall together. Interestingly there has been no change to our earnings estimates or the outlook of our portfolio companies. In fact, expected earnings growth for our portfolio companies is over 20% for each of the next two financial years, close to the highest we have seen,’ Scott said.

Scott said Narain took advantage of the correction to add a handful of companies that had been on his watchlist, although she did not say which.

She highlighted the pace of earnings growth across the portfolio of financial and consumer stocks, which currently trades at a 12-month forward price to earnings ratio of 20.5 times, meaning £20.5 would buy £1 of earnings, which is expected to drop to 16.7 times in 2026 as earnings swell.

Recent annual results showed that shareholder returns of 34% underperfomed the benchmark’s 38% over the 12 months to the end of December, a gap that emerged in the last quarter of the year as the benchmark saw a sharp rally led by public sector companies which IGC does not invest in, Narain said. 

He added that the foundations for prolonged annual GDP growth of 6%-7% in India had already been set, with a favourable regulatory environment, improved infrastructure, healthy corporate balance sheets and policies geared towards investment led development. 

‘What has come as a bonus is geopolitics. The rush to de-risk supply chains is accelerating investment by global firms into India, many of whom are viewing India as an alternate to China especially since demographics are extremely favourable. We thus believe the momentum in the economy will remain strong,’ he said. 

Stock exchange filings show the board was quick to start buying back shares when a discount emerged, spending £218,000 over 18 and 19 March as the shares troughed. Only a week earlier, it had raised £167,200 selling shares on a 0.7% premium. At month end, it bought back a further £161,400.

The fund’s five-year shareholder returns of 77% are ahead of the AIC sector average of 34%, but trail the benchmark’s 135% gain. 

March mid-cap collapse

Source: Morningstar