Small caps log worst drop in five months as retail investors unwind leveraged bets

A wave of deleveraging by retail investors triggered the biggest rout in Indian small-cap stocks in five months, as mounting concerns over inflation and higher interest rates weigh on sentiment, according to a Bloomberg report.

The selling was exacerbated by the unwinding of positions funded by margin loans, brokers said, hitting one of the few pockets of India’s $4.8 trillion market that have bucked broader weakness this year.

An index of small-cap companies tumbled 2.8 per cent Friday, the most since May 12 and erasing its gain for the year. Smaller stocks account for the majority of leverage-based wagers by retail traders, and forced unwinding of these positions has likely left retail investors with mark-to-market losses of ₹9,000 crore, according to Kotak Neo’s chief business officer, Ashish Nanda.

“There’s a liquidity crunch on the small-cap side, with a lot of selling driven by leverage and fear,” Thomas Priju, a portfolio manager at Karma Capital, told Bloomberg.

The intensity of the selloff was reflected in the 14-day relative strength index — a gauge of momentum — which closed at its lowest reading in over four years.

Small caps had been outperforming until the recent resurgence in oil drove up bets on further central bank rate hikes to tame inflation. Their earlier rally had been fuelled in part by large inflows into mutual funds this year, with small-cap funds receiving a record ₹10,400 crore and mid-cap plans drawing ₹7,830 crore in September, according to the Association of Mutual Funds in India.