The gap in the market capitalisation of theNifty 50 and the NSE free-float small-cap 100 has come down sharply to 13.4 times from 15.2 times in the last one year, according to data provided by Capitaline. The gap was hovering at around 15 times between 2011 (oldest data available for small cap index) till 2016.

A lot of the outperformance of the small cap index relates to the composition of sectors forming the index. According to the latest available data on the NSE (November 30), financial services (led by public sector banks), energy and information technology are the top three sectors in terms of weightage in the Nifty 50. In the case of small-cap, it is consumer goods, financial services and construction. Also, the small-cap index is more spread out in terms of sectors than Nifty (62 per cent by the above three sectors).

Consumer goods companies (Nifty FMCG index) have been one of the top five best performing sectors in the last one year while pharmaceutical, IT and public sector banks have been the underperformers. Hence, the outperformance of the small-cap index over benchmark.

The second reason is robust inflows, especially from domestic mutual funds and high networth individuals, into small- and mid-cap indices due to superior financial performance and niche businesses. Volatility in globally-focussed large-cap stocks (many) due to activity of foreign institutional investors in the derivatives market or as part of their global allocation strategies also made domestic-driven small-cap stocks more attractive.

While liquidity of stocks (read free-float) is lesser in case of small-cap stocks, their financial performance has been superior. “Small-cap companies have been delivering double-digit earnings growth which has not been the case with many Nifty 50 companies. Thus, there has been too much money chasing too few small stocks,” said Dharmesh Kant, an independent analyst. He last worked as head-retail at Motilal Oswal Securities.

The third reason is the series of initial public offers that came to in the market in the last one year, which resulted in record capital raising and many blockbuster listing performances. Good performances by newly-listed companies such as PC Jeweller and Dilip Buildcon which raised money through the primary market have been part of the small-cap index and figure among the top 10 companies of the index by weightage. These companies have seen phenomenal rise in their stock prices. While PC Jeweller is up 137 per cent in the last one year, Dilip Buildcon has gained 369 per cent.

The NSE Small Cap index trades at 100 times trailing price-to-earnings multiple compared to 26 times for Nifty.

Experts say the party for small-cap stocks will continue as long as they perform and markets move up. As regards financial performance, the current quarter is expected to be good for India Inc as everything is in favour of companies — low base caused by demonetisation, good monsoon and benefits of GST.

Small-cap companies are expected to do even better due to their small size and high operating leverage.