Mid cap funds are the haute couture of the Indian mutual fund industry. They are hot, in vogue, and ardently sought after, and, not without reason.
Of course, if you are still in awe of the Sensex's rise over the past few years, you have completely overlooked the pulse of the market - the spectacular rise of mid-cap stocks. With the BSE Midcap's annualised return of 45% during the past four years, the Sensex return of 40% is pale in comparison. Mid-caps finally have their place in the sun with almost every fund house having a dedicated mid-cap fund.
From the list of diversified equity funds, we shortlisted those having an average allocation of over 50% to mid and small-caps over the last three years (August 2003 - July 2006). Our list narrowed down to 24. Over a three-year period ended August, of the top 15 performers in the diversified equity funds, as many as 11 belonged to the above set of 24. The annualised returns of these funds stood at over 50% taking into account the May correction.
High return, but with high risk
Smaller companies offer more potential for growth and have a long way to go before they become too large to sustain that growth level. They tend to be more nimble and react faster to changes. This is the where you can scout for multi-baggers and get to invest in the future large-caps. But that is just one side of the picture. And too often, that is the only aspect considered by investors.
Despite the glamorous returns, mid-caps are a risky investment. While everyone tends to harp upon the fact that at one time Infosys and Bharti Airtel (earlier known as Bharti Televentures) were mid-caps, they are mum on the fact that there are a lot of mid-caps that will not grow into large-caps. Some will not be equipped to survive a bad phase since they have insufficient financial resources. Some will do better than the rest. Mid-caps tend to combine the characteristics of large-caps and small-caps by offering more growth than the former and less risk than the latter.
Being characterised by lower market capitalisation and limited liquidity, when such a stock witness huge inflows, their prices zoom irrespective of the fundamentals. Picking up this trend, naive investors pump money into it and sooner or later end up losing money.
Historically, mid-caps have displayed the tendency to rise more than large-caps in a booming stock market and plunge to greater depths when the market dips. From the peak of May 10 to June 14, 2006, when the market bottomed out, the Sensex lost 29% but the BSE mid cap lost 38.32% while BSE small cap, 42%.
Among the diversified equity funds, the higher the investment in smaller stocks, the more severe the impact on returns. The funds that were ranked among the top 25% during May 10 to June 14, 2006, had an average 66% invested in large-cap stocks, and less than 10% in small-caps (see Table: Quartile Classification). On the other hand, the worst 25% had just over 40% in large-caps and 22% in small-caps. Little wonder that for the three-year period ending August 31 the CNX Midcap had a standard deviation of 8.05% while the S&P Nifty had 6.95%.
No easy task
Even if you are still willing to take a chance with mid-caps, choosing the right pick is no easy task. The universe of mid-cap stocks is larger than the large-cap players while the quantity and quality of information available on them is much less. Being rather illiquid, the maximum benefit will accrue to the earliest entrant. So the challenge lies in picking up a winner before anyone else does. A primary concern among the top-performing mid-cap funds is their huge size. Reliance Growth is over Rs 2,000 crore in size while Franklin India Prima boasts of assets exceeding Rs 1,700 crore. The relatively younger but well established Sundaram BNP Select Midcap has also crossed the Rs 1,000-crore mark.
Why does the size of the fund matter? With mid-caps being illiquid stocks, huge holdings in them could severely hamper price and exit options. A small fund is more agile and can enter and exit mid- and small-cap stocks according to changes in the market conditions but a big fund will not have this much of flexibility. Moreover, the larger the fund, the lesser is the impact of a single multi-bagger. Even if a huge fund has a substantial stake in a mid-cap, it will only form a miniscule part of the overall portfolio. However, there is not much evidence to conclusively say that the size of the largest mid-cap fund is leading to under-performance.
Are mid-caps your cup of tea?
Mid-caps truly reflect the stock market story - the growth of companies, which in turn reflects the growth of the economy. The best way you can ride the growth wave is by buying and patiently holding on to mid caps for years. If patience is a virtue you boast of and you are not averse to some amount of risk, you should consider a mid-cap fund.
No comments:
Post a Comment