Mid and smallcap scrips have taken a pounding this year. The BSE smallcap index is down more than 38% in 2011 while the BSE midcap is about 28% in the red. Both the indices are at a 27-month low and were last seen below this level in August 2009.

The pressure on these stocks intensified after Monday?s bloodbath. Margin calls were triggered in several of these scrips as their share prices crashed following a selloff from lenders to whom shares were pledged by promoters.

The share price of Shree Renuka Sugars, for instance, tanked over 5% in intraday trade on Monday and closed 5.42% in the red. The reason for the freefall was the announcement that company?s promoters had pledged additional 1.69 crore shares. The scrip had touched a 52-week low last week.

Typically, the proportion of pledging in mid and small caps is higher than in the large caps,? observed Sudip Bandyopadhyay, managing director and CEO, Destimoney Securities. Pledging too many shares can also result in the promoter losing control of his company, said market observers.

Risk aversion is another major reason the small and mid-cap stocks have taken a beating. ?Whenever there is a crisis there is a tendency to move away from risky assets. That explains why in these times of uncertainty investors are flocking to safe havens such as gold and the US treasury. Similarly, investors are moving away from the riskier small and mid-caps into the large caps,? said Bandyopadhyay. The BSE Sensex has slid more than 20% in the year to date.

Rising interest rates has also hurt the smaller companies as it has substantially increased the cost of capital and impacted their profit margins. To make matters worse smaller firms with revenues of about R100 crore can typically borrow only up to 20-25% of their turnover from banks for their working capital needs, say market observers. The RBI raised its repo rate last month for the 13th time since March 2010.

This year a number of smaller firms have rushed to tap the primary market for listing. Share prices of many of these companies have seen significant erosion.

Of the 37 companies that have listed in the calendar year 2011, 29 companies have hit the market with an issue size of under or just over R100 crore. Of these 29, 18 firms are currently trading below their issue price.

Most of these issues were oversubscribed despite poor participation from institutional investors owing to a good response from non-institutional investors and retail individual investors. The lack of liquidity in these counters has also backfired in a choppy market. ?It?s mostly the retail investors who are invested in these counters and many of them are sensitive to market sentiments,? pointed out P Phani Shekhar, fund manager ? PMS, Angel Broking.

Corporate governance issues have also dogged several of the small and mid-cap firms. ?It?s not that all small and midcap firms have governance issues but yes by and large there is a question mark on how many of these firms are run,? said Bandyopadhyay. Government inaction on the policy front has also been a dampener for the smaller firms, particularly those in the infra space, said market observers.

Market participants say things could get worse before they get any better and that retail investors ought to adopt a wait-and-watch approach before investing in these scrips. ?Either the retail investors should wait out this uncertain period or invest in good midcaps with a long term horizon of more than a year,? said Shekhar.