S. Naren or Sankaran Naren is a veteran investor and the Chief Investment Officer (CIO) at ICICI Prudential AMC, one of India’s largest mutual fund houses. And recently, he spoke to a gathering in which he urged investors to exercise caution while investing in small and mid cap stocks. This speech has now gone viral with many people blaming him for inciting panic. 

So in today’s Finshots, we look at the actual contents of the speech, see if there’s any merit in his claims and whether people should be blaming him for the current sell-off in the small and mid-cap segment. 

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The Story

The speech may have lasted only twenty minutes, but it contained some sweeping claims—so let’s begin with the biggest one.

One of the first points he makes is that small and mid-cap companies look extremely expensive right now—even compared to 2008, when valuations were already quite high.

Small and mid cap companies are the smaller and medium-sized players in the stock market—not the massive industry giants. Their total value (market capitalization) sits below the largest 100 or so big-name firms, which often makes them riskier to invest in.

But despite the risk, their value has shot up like crazy. People investing in small and mid cap companies in the past few years have gone to make life-changing wealth. This has only fuelled others to participate in the rally and as a consequence, Mr. Naren believes many of these companies are currently overvalued. 

To illustrate this fact, he uses the “median Price to Earnings ratio”. 

Think of each stock’s price as the cost you pay to “own” a portion of its yearly profits. The price-to-earnings (P/E) ratio tells you how many rupees you need to pay for one rupee of a company’s annual profit. 

Back in 2008, even at the market’s high point, most small and mid-sized companies had lower P/Es. Today, many of those same types of companies have P/E ratios closer to 43. In other words, you now pay a higher price for every rupee of profit compared to 2008, which makes small and midcap stocks look a lot more expensive.

However, that’s not the only problem.

The momentum is breaking and it seems the valuation isn’t constantly going up as they once did. If these cracks get any bigger, it won’t just affect a few people. It will likely affect everyone. And Mr. Naren points to another interesting trend to highlight this fact. 

Companies pre 2007-2008 relied heavily on bank loans for expansions or acquisitions whereas today they rely on “your money”.

For instance, before 2008, Suzlon Energy pursued a global acquisition spree (like buying out RE energy systems in Germany), predominantly funded by debt. Kingfisher Airlines financed its Air Deccan purchase and new aircraft via bank loans, and Reliance Communications (Anil Ambani Group) spent massive amounts of money on GSM/CDMA rollouts and 3G spectrum, again fueled largely by borrowed capital. 

But companies today – They do something very different. 

Instead of relying on bank loans, they seem to lap up equity capital. 

Think of companies raising money by selling shares to investors for cash – like an IPO. It’s not debt and there’s no interest burden either. And companies seem to love it at the moment. In 2024, nearly 317 companies raised more than ₹1.8 lakh crores through IPOs (a record). And domestic mutual funds were big participants. They invested nearly ₹20,000 crores before these IPO went live (through anchor investments encouraging others to also buy into the IPO).

And they have been doing it consistently for the past few years. In fact, in 2022 and 2023, they invested more than foreign portfolio investors. 

So here’s the problem.

Mutual fund houses have a lot of money coming into their funds because SIPs “sahi hai”. And even though some fund houses have stopped accepting new inflows, a lot of money has already made its way into the primary market. So now, even if a few small and mid cap companies fail, it’s your money on the line. You will bear the brunt of this burden, instead of banks.

Also, there seems to be a notion that you can do no wrong when you commit to an SIP. An  SIP is a systematic investment plan. In other words, even if you have all the money in the world, don’t just invest all of it at once. Instead, you funnel a little bit of money each month, or each week at regular intervals and keep doing it consistently. This way, if small and mid cap companies fall in 6 months, and then shoot up in value again a couple of years later, your returns will average out and you will likely come out of this transaction looking like an absolute winner. However, Mr. Naren warns that recent SIPs started in small/midcap (post-2023) are likely to have poor returns unless held for 20 years (which is rare).

Once again he illustrates several examples to drive home his point. 

SIPs done in Indian midcap funds between 1995 and 2002 would have delivered zero to negative returns. Between 2006 and 2013: SIP returns in midcap funds, again, were negative. And between 2014–2024 SIPs would have yielded a big negative return even in China and Brazil.

So “SIP and forget” may not be a smart strategy especially if you’re invested in small and mid cap funds. 

And finally, he issues a stark warning to mutual fund managers. 

Right now, mutual fund managers are swimming in cash. Equity mutual fund managers alone handle ₹30 lakh crores worth of assets (a 40% increase from the previous year). 

With this kind of money, it’s natural for a fund manager to make a few mistakes. But Mr. Naren cautions that even small mistakes can be increasingly costly when you have increasingly large schemes. 

For instance, consider an ₹80,000 crore mutual fund scheme. A 2% mistake (in allocating funds) would mean ₹1,600 crores in capital. Now imagine a fund manager having to sell ₹1,600 crores worth of stock because the company is no good anymore. It’s not easy. And even worse, if people still demand the mutual fund manager to return their money, he will have to sell stuff that he may not even want to sell. This sell off could trigger even larger panic across the market and everybody could lose money here.

So if a mutual fund manager isn’t prepared to handle investor withdrawals, they may be doomed.

However, it’s important to note that Mr. Naren’s speech wasn’t all doom and gloom. He did note that the Indian economy remains resilient and that he’s optimistic about its continued growth. His main caution pertained to investing in small and mid-cap funds (stocks), suggesting that investors should instead consider large-cap (tried-and-tested) or flexi-cap funds (where fund managers can move freely between large- and mid-cap shares). 

That’s all. It was not controversial at all. If anything, it was actually a pretty reasonable take.

And even though some people are currently blaming him (and his speech) for the current sell-off in small and mid-cap stocks, a quick look at news reports shows that fund managers across the industry have issued similar warnings. 

For instance, in September 2024, HDFC Mutual Fund stated that raising one’s allocation to small and mid-caps solely because of recent outperformance could be counterproductive (here’s the report). In December 2024, a panel of fund managers echoed similar caution for people investing in small and mid cap stocks. Hell, even SEBI restricted inflows into small- and mid-cap mutual funds early last year.

So Mr. Naren isn’t alone—nor is he the first—to raise these concerns; the only difference is that in his speech, he was unequivocal. There were no doubts, no if’s and but’s, no sugarcoating. While other fund managers tempered similar comments with pockets of optimism (perhaps to preserve their commissions), Mr. Naren spoke with conviction, even if it hurt the fund house. 

For this, he must be lauded. Instead many have turned him into a convenient scapegoat just because his speech coincided with a major sell-off in small and mid-caps. 

That is unfortunate. We hope that people have the good sense to see that Mr. Naren was only the messenger. The writing, dear readers, has been on the wall for quite a long time now.

Until then…

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