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Making hay while the sun shines

After a go-nowhere period of two years, mid-cap funds are again on a tear. Here's what you should do now.

Making hay while the sun shines

Mid-cap funds have posted bumper returns since the reversal of the market direction last year. Since April 2020, the S&P BSE 150 MidCap TRI has risen by 87.73 per cent as against the Sensex TRI's 62.21 per cent. Mid-cap funds had been through a lean period for two consecutive years previously and many found it difficult to match even fixed-income returns.

As you may already know, mid-cap funds are mandated to have a minimum allocation of 65 per cent to mid caps, which comprise stocks ranging from the 101st to the 250th company based on market capitalisation.

Returns driving AUM
Currently, the AUM of mid-cap funds stands at over Rs.1.42 lakh crore, which is the third largest among all equity-oriented fund categories. This AUM has grown by more than Rs.38,600 crore this year. With the category seeing a net inflow of just Rs.5,700 crore this year, this growth in AUM has been mainly driven by the returns that the mid-cap funds have generated. As of August 2021, an average mid-cap fund has delivered more than 36 per cent this year.

Mid-cap funds had witnessed net outflows for eight consecutive months from July 2020 to February 2021 (see 'Missing the party'). However, the quantum of inflows that the category has absorbed in the five months since then has been more than the aggregate of the previous 21 months. Thus, amid the runaway rally in the market, investor interest in this space seems to have been renewed.

However, investors seem to have missed a major portion of the rally, as can be construed from the net outflows during the eight months mentioned above. We observed a similar trend in small-cap funds as well. Given the mega rally, those who have just started investing in mid/small-cap funds should adjust their return expectations (see 'Short term vs long term') or even brace for a correction, which often follows after a rally has gone too far.

To tap the rising investor interest in this category, three funds (out of which two are index funds) have already been launched this year. Value Research has always maintained that one should avoid NFOs and new funds and stick to the tried-and-tested ones, more so in this risky market segment where the cost of going wrong with fund selection can be very high.

What to do now
If you have an allocation to mid-cap funds in your portfolio, it's very likely that the rally has elevated your allocation to them. Hence, it's a good time to rebalance your portfolio and restore your original allocation to mid caps. Avoid the temptation of increasing your allocation to this segment as history suggests that corrections are especially severe for mid/small caps. Don't forget that allocation to mid-cap funds should play only a supplementary role and even in an aggressive portfolio, they should never exceed 20-25 per cent of the total equity allocation. If you don't want to take extra risk, you can always do with three-four flexi-cap funds and avoid this category altogether.

Also, since returns from this segment tend to come in short bursts and cannot be predicted in advance, the best way to profit from this rewarding but volatile category is through SIPs. Importantly, maintain a long-term horizon of at least seven to 10 years for the best return experience from mid caps. While exiting these funds, go for SWPs.

Interested in our fund recommendations in the mid-cap space? See the October 2021 issue of 'Mutual Fund Insight'.