Investing in mid caps and small caps during these times of market decline? Is it being stupid or intelligent?
18-Jul-2022 •Dhirendra Kumar
'What a strange time to be writing about mid-cap and small-cap funds', you must be thinking. Right now, mid-cap and small-cap stocks and the mutual funds based on them are reeling from months of sustained losses. Investors holding them have seen a large proportion of their investment value melt away and yet - yet Value Research is trying to talk you into investing in such funds. Stupid.
However, there's a big 'however'. At this point of time, no mutual fund salesperson or website will try to make you invest in mid-cap and small-cap funds. However, for the exact reason that most people will avoid such funds right now, smart investors will look at them closely. This is, in fact, the best time to talk about investing in mid-cap mutual funds. If you take a longer-term view, as we have done in our cover story of 'Mutual Fund Insight' August 2022 issue, you will see that to reap the rewards of equity, you must get rid of kneejerk reactions and dispassionately imagine the case for investing.
The first thing we must appreciate is that there's nothing, absolutely nothing, in all of equity investing that matches the payoff that one gets for starting with the stock of mid-cap companies that become large-cap within a few years. That's for equity investors who buy stocks directly, but mutual fund investors have an even better deal. They get to capture much of the advantages of mid-cap equity investing, but with much less hard work and pain, and certainly much less risk and variability.
The key to managing mid-cap stress is to understand that these funds can only mitigate the variability; they cannot eliminate it. The volatility and the variability that happens in mid-cap investing is just the other side of high long-term returns. As in every type of investing, risk and reward are twins, and one is not found without the other. Still, that's a problem for most of us. As we have seen for the umpteenth time, when mid caps fall, they fall a lot, and fall quickly. There are many reasons for this, for example, the relative lack of liquidity in such stocks. The result is that mid-cap investors see a much deeper erosion of investment value when the bad times hit.
The problem is that when mid caps fall, many investors feel that there must be a solution to this problem, but they just didn't know it. Perhaps, they chose the wrong funds. Or they feel there was some signal to sell their mid-cap fund investments that they missed. Or maybe they should sell and get out anyway. Maybe they should stop their SIPs. No one told them what to do!
These are all self-destructive actions. They are based in the belief that mid-caps funds are just like large caps except that they have higher returns. That's just not true. The volatility is part of the story - there's nothing to be done except carrying on with your SIPs and holding on for the cycle to turn. This is not a matter of investing but of the psychology of the investor, of having confidence in the funds that you have invested in and of your understanding of the concept of mid-cap investing.
That may sound as if this is an innate quality but it isn't. This state of doubt and confusion is where every investor is at the beginning of the mid-cap investing journey. Every time NAVs fall, new mid-cap investors panic. What makes the difference eventually is experience and knowledge. One of that comes with time, and the other is our job here at Value Research. Our cover story of 'Mutual Fund Insight' of August 2022 issue takes you through all aspects of mid-cap and small-cap investing, and the accompanying reviews of the set of chosen funds will give you a nice sampling of the fund-selection process for these funds. By approaching mid-cap investing systematically, you will be well prepared to stay the course and earn the high returns that mid-cap funds can generate.
Suggested read: Keep the ball rolling
This editorial appeared in Mutual Fund Insight August 2022 issue. To read the cover story and other insightful analyses, columns and articles