There is optimism among market participants that the fund flow from foreign institutional investors (FIIs) will strengthen in the coming months as a major victory for the Bharatiya Janata Party (BJP) in assembly elections has improved the chances of the party coming to power at the Centre next year.

Investments by FIIs in the stock market, which have already crossed the Rs 1-lakh crore mark this year, are expected to improve further as liquidity boosting by the US Federal Reserve is unlikely to end anytime soon.

According to an average of 10 analysts’ estimates compiled by Bloomberg, the S&P BSE Sensex will climb to almost 22,200 by the year-end if the BJP comes to power in four of the five states that went to the polls recently. The Sensex ended at 20,996 on Friday.

However, considering that both the BSE Sensex and the NSE’s Nifty are trading close to their all-time highs, investors , particularly FIIs, will shift their focus to quality mid- and small-cap stocks, as there is very little headroom for large-cap stocks to rise further.

The BSE Midcap and small-cap indices, though gained in recent times, are still far away from their all-time highs. In fact, most are ruling at least 30 per cent lower than the peaks they had achieved during the boom period, which culminated in the 2008 bear onslaught.

Marc Faber, global investment guru, recently told CNBC in an interview that he saw an opportunity in mid- and small-cap stocks in India.

Historical data indicate that whenever the markets bounce back, mid- and small-cap indices rise faster than the overall market. However, it would be prudent to take a company-specific view rather than a sector-specific approach, particularly in the mid-cap area as companies within the same sector can often have very different profiles.

Investors should put faith in companies that are aspiring to be leaders in their respective fields.

Other important factors to be kept in perspective before investing in a stock include sound management, good governance, low-level of pledged shares by promoters and sound balance sheets: positive and growing free cash flow, sales growth and resilient order book, and margin expansions.

Besides quantitative parameters, such as low-debt ratio, high interest coverage ratio, high return on equity and liabilities in the form of foreign currency convertible bonds or external commercial borrowings should also be considered before investing.

Among the sectors, select banking, infrastructure and capital goods shares are offering more value at this point in time.

However, investors should bear it in mind that mid- and small-cap stocks are more volatile in nature than the large-cap stocks due to the liquidity factor. Most stocks will, therefore, correct faster than the market if the overall trend turns bearish.

So, the safest bet for investors to channel their investments in this sector would be through mutual funds. There are many mutual funds that focus on mid- and small-cap stocks.

>badrinarayanan.ks@thehindu.co.in

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