The broader markets have had a party in 2023. The Nifty Midcap and Smallcap indices, having gained over 25 percent each so far in 2023 are trading at a record high. While some analysts project more upside, Pankaj Tibrewal of Kotak Mahindra AMC is turning slightly cautious.

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However, he continues to maintain that they continue to be wealth creating and one of the best performing across all equity classes.

In an interaction with CNBC-TV18, Tibrewal highlighted the three reasons why he is cautious on the small, mini and microcap space. Here they are:

Shorter and Sharper Cycles

Tibrewal said that over the last 10 years, Smallcaps have given a Compounded Annual Growth Rate of 21 percent, while Midcaps have given 19 percent. Both have outperformed the Nifty 50 index by a wide margin.

However, the cycles are becoming shorter and sharper. "To survive and create wealth in the long term, we need to be cognizant about the near as well as the short-term," Tibrewal said, adding that certain indicators within the mid and smallcap space are pointing towards caution.

Similar Earnings Yield Compared to Large Caps

Earnings yield of large, mid and smallcap profitable companies across all indices are almost the same, according to Tibrewal. Earnings Yield is calculated by the Earnings per Share of a financial period, divided by the current share price. It is the reciprocal of the Price-to-Earnings ratio.

"When you look at earnings yield across the same segment, why to take additional risk in mid and smallcaps where the mortality rate is much higher than largecaps," he said.

Market Cap and Profit Disconnect

Tibrewal highlighted that mid and smallcap stocks as a percentage of free float market cap is currently at 31 percent, nearing an all-time high.

In terms of the profit distribution, largecaps constitute 75 percent of the profit while broader markets have the rest. "So there seems to be a disconnect on the profit distribution versus market cap distribution, as we see today," he said.

Strong Fund Flows

Indian equities have seen flows worth close to $16 billion so far this year. Tibrewal highlights caution over people assuming that mid and smallcap stocks are a way to "financial nirvana."

"Mistakes made in 2017 had repercussions in 2018 and 2019. Our advise is that please don't make mistakes right now because somewhere, 2017 still seems to be fresh in our our minds," Tibrewal said.

After a sharp surge in 2017, the Nifty Midcap index declined 15 percent in 2018 and another 5 percent in 2019.

Pockets Of Opportunities

Tibrewal said that there are pockets of opportunity in the market but in the near-term, market participants are focusing more on P&L instead of balance sheet and cash flow. "That is something which needs to be worried about and hence a lot of flows are coming into the mid and smallcap funds," he said.

Over Rs 30,000 crore have come into small and midcap funds over the last six months, 1.9 million folios have been opened in the smallcap funds and they are above their historical averages in terms of valuations.

"From a mid and long-term, we continue to be positive, but there seems to be some kind of greed, which is clearly visible in the near-term and one needs to be careful about it," Tibrewal said.

(Edited by : Hormaz Fatakia)