Active mid, small-cap funds look smart in this market correction

Active mid- and small-cap funds have demonstrated that when the going gets tough, the tough get going. Consider this: between March 2023 and September 2024, when the market was doing well, only 11 of 29 active mid-cap funds and 3 of 24 active small-cap funds were beating their benchmarks. But since the market's 10 per cent dip in late September 2024, the tables have turned dramatically: a remarkable 28 of 29 active mid-cap funds and 26 of 28 active small-cap funds have outperformed their respective mid- and small-cap benchmarks.

What explains this dramatic turnaround? Let's look at what the numbers say.

Dodging the downers

We first identified the stocks that have fallen more than 15 per cent during the recent correction. Our analysis revealed that these heavily-falling stocks constituted 32.4 per cent of the mid-cap index and 28 per cent of the small-cap index.

However, most active mid- and small-cap funds maintained significantly lower exposure to these stocks. Only two mid-cap funds, Quant and ITI , had higher exposure than their index.

The value of active management

By mandate, mid- and small-cap funds are required to invest at least 65 per cent of their assets in their respective market cap segments. It's up to the fund manager to decide where to allocate the remaining 35 per cent. With large, mid and small caps falling equally by 10 per cent in this correction, value addition has come from the following:

a) selecting the right stocks from each segment

b) sitting on cash and waiting for the market to cool down

We analysed the funds' alpha-the measure of how much a fund's returns exceed its benchmark's returns adjusted for the allocation it maintains across the market cap. During the correction period from September 26 to November 18, 2024, several funds stood out:

Both the mid- and small-cap schemes of Motilal Oswal Mutual Fund led their respective categories. Similarly, both the mid- and small-cap schemes of HDFC Mutual Fund made it to the top five. On the flip side, Quant's mid-cap was the only fund in its category that failed to beat the index, while its small-cap fund has managed to beat the index by a modest 1.4 per cent.

Our take

This market correction is a powerful reminder of the importance of stock selection in the mid- and small-cap space. While index funds have their place in an investment portfolio, skilled fund managers can add significant value through careful stock selection, especially during market downturns. That's active management earning its fees.

Also read: First-ever multi-cap fund ratings revealed