Mid- and small-cap funds: Time to reassess your allocations

Mid and small-cap companies, which are beyond the top 100 companies by market value, have grown leaps and bounds recently. In the last 18 months, 12 mid caps have grown to become large caps, while 17 small-cap companies have moved up to the mid-cap tier. Given the context, the growth potential of mid- and small-cap funds is undeniable. However, it comes with high risk. Mid and small-cap funds are, at best, meant for an allocation of no more than 25-30 per cent of your portfolio. Don't treat them as a short-term play or overcommit to this space. Category Snapshot for 2024 Parameters Mid cap Small cap Number of actively managed funds 29 28 Assets Rs 3.79 lakh crore Rs 3.14 lakh crore Asset-weighted expense 0.65 0.62 Average expenses - Index funds 0.22 0.31 Asset-weighted category returns 30% 27% Average return of top quartile funds 37% 33% Average return of bottom quartile funds 25% 20% Average large-cap exposure 13% 8% Average mid-cap exposure 70% 14% Average small-cap exposure 18% 81% Three most popular funds Motilal, Quant, HDFC Quant, Nippon, SBI Three least popular funds Axis, DSP, PGIM Aditya Birla, DSP, Kotak Note: Expense ratio as of June 30, 2024. Returns and portfolio-level attribtues are as of July 31, 2024. Popular funds based on net flows up to July 19, 2024. Highlights and trends Performance: Mid- and small-cap funds have been on a tear since 2023. Small-cap funds already achieved 60 per cent and mid-cap funds 70 per cent of last year's returns. Valuation peaks: The 250 small-cap index to Sensex ratio can convey the valuations in the small-cap segment. This ratio has hit a peak not seen since the 2018 mid- and small-cap surge. Rising P/E multiples further highlight this trend. About 40 companies in the 250 small-cap universe now have a P/E ratio of over 100, compared to just 4 in 2019. Fund size: As AUM of these funds has grown, so has the market structure, nearly doubling over the last five years. This expansion provides some balance, even as fund sizes increase. Stress test: SEBI's new liquidity stress tests reveal that larger AUM funds take longer to liquidate. Many funds are working to shorten this duration, ensuring smoother withdrawals during volatility. Portfolio adjustment: The current rally may have substantially inflated your allocation to mid and small-cap funds. A 30 per cent SIP allocation, 15 per cent each to mid- and small-cap index funds, at the start of March 2022, would have ballooned to 38 per cent. This increase calls for trimming your positions to avoid overexposure. This will help manage risk. Remember to focus on your set portfolio allocation rules, not market levels. Suggested read: The small-cap champions Changes in recommendation Funds moved to 'Buy': Mahindra Manulife Mid Cap Fund moved to 'Hold': ITI Mid Cap, SBI Nifty Midcap 150 Index, ICICI Pru Nifty Midcap 150 ETF, ICICI Pru Nifty Midcap 150 Index Funds moved to 'Sell': Aditya Birla SL Nifty Midcap 150 Index, UTI Mid Cap Funds moved to 'Avoidable': Edelweiss Nifty Smallcap 250 Index, HDFC NIFTY Smallcap 250 Index, Kotak Nifty Smallcap 50 Index, Motilal Oswal Nifty Microcap 250 Index Funds at a glance Fund name Rating 5Y SIP return (%) Alpha Large cap exposure (%) Avg. no of stocks Expense ratio (%) Assets (Rs cr) Mid-cap funds BSE 150 MidCap TRI - 37 - - - - - HDFC Mid-Cap Opportunities 4 37 4.7 8.2 70 0.72 75,382 Kotak Emerging Equity 4 35 2.1 12.5 77 0.34 50,602 Nippon India Growth 4 38 2.7 19.5 98 0.79 32,971 Axis Midcap 3 29 -1.3 22.3 83 0.53 30,855 SBI Magnum Midcap 3 33 2.5 5.8 76 0.80 21,127 DSP Midcap 1 28 -6.0 10.3 58 0.70 20,014 Mirae Asset Midcap 2 34 -1.4 8.0 73 0.57 17,455 Motilal Oswal Midcap 5 42 12.1 13.9 28 0.58 14,446 Franklin India Prima 2 32 -1.8 12.4 73 0.94 12,529 Sundaram Mid Cap 3 33