Indian equity investors have largely seen a declining market this year, thanks to the unpredictable election outcome. But recently, mid-cap stocks have made a smart recovery and everyone is talking of mid-caps nowadays. In the past three months, CNX Midcap 200 Index is up 24 per cent as against the Sensex's 8 per cent gain, and fund managers haven't been tardy in latching on to the trend. As on August 31 this year, 47 per cent of the funds had mid- and small-cap oriented portfolios as against 35 per cent of funds in December 2003. And among the top-10 performing funds of 2004 so far, six have mid-cap tilted portfolios.
The major movers from large-cap oriented portfolios to mid-caps are Alliance Basic Industries, UTI Grandmaster, HDFC Growth Fund, Reliance Vision, Magnum Contra and Canglobal. There is also a visible shift towards small-caps. Five funds have turned more aggressive towards small-caps after maintaining a mid-cap tilt for long. These are Reliance Growth, Bonanza Exclusive Growth, Taurus Starshare, Taurus Discovery Stock and Sundaram Select Midcap.
This trend is not only true of the diversified equity funds; most sector funds have also taken heavy positions in mid-caps in recent months. For example, three of the seven technology funds and two out of three FMCG funds have mid-cap oriented portfolios as on August 31. The trend is more dramatic in case of pharma funds. Here, of the total five funds in the category, four have mid-cap biased portfolio. The only equity category where this trend has not dominated is the index funds for the obvious reasons of sticking to the large-cap index composition.
2003 was the best year for the mid-caps when mid-cap funds like Franklin India Prima topped the category of diversified equity funds gaining 177 per cent. Sundaram Select Midcap was the third best fund - up 157 per cent. The only mid-cap fund to be an average performer was Birla Midcap, which gained 113 per cent. Following this robust gain, three more mid-cap funds have been launched this year - UTI Midcap, Chola Midcap and Prudential ICICI Emerging STAR.
Should You Bet on Mid-caps?
Though there's higher gain potential for mid-cap funds but it isn't all gain without pain. For instance, Franklin India Prima's worst 3-month return has been negative 50 per cent (in 2000). Even the fund's worst one-year return stands at minus 50 per cent in 2000-01. This would have meant a huge loss and, in some cases, a big capital loss to the investors. Thus, one would have to be a strong hearted to withstand such a fall because to overcome such a loss of 50 per cent, the fund has to grow by another 100 per cent.
The risk is not confined to the investors. A mid-cap portfolio can suffer illiquidity. Mid-caps stocks are not frequently traded in the bourses, which could result in crisis in case the fund receives a large redemption order. And the fund manager has to keep a close tab on their stock selection since mid-caps are more prone to become small-cap (resulting in big losses) than becoming a large-cap. For instance, out of 158 mid-caps stocks in January 2003, only 6 stocks managed to climb to large-cap category till March 2004 and 41 stocks, in fact, turned small-cap. Mid-caps are also susceptible to higher volatility as can be seen from standard deviation of Franklin Indian Prima, which is among the highest in the category.
All Mid-cap Oriented Funds Are Not Equally Risky
So far, we have focussed on the broad categorisation of an equity fund's portfolio. It's quite possible that some of the fund's portfolio may be near the borderline of the mid- and large-cap break-up. The risk is relatively low in these sorts of funds compared to those having a heavy mid-cap tilted portfolio. To distinguish such portfolios, one should look at the weighted average market capitalisation of the fund's stock portfolio. As per Value Research Fund Style, funds that had market capitalisation of over Rs 4,200 crore were classified as large-cap funds and those below this figure were classified as mid- and small-cap funds as on August 31. This figure changes every month.
Our point here is that all funds showing mid-cap fund style may not be as risky as the other. For example, Reliance Vision and Alliance Equity have market cap of nearly Rs 3,800 crore and funds like Magnum Global and Chola Midcap have market cap of Rs 900 crore, but all four have been clubbed as mid-cap funds. There is a huge difference between the former two and the latter two funds in terms of the liquidity risk and the portfolio risk, with latter having the higher of both.
We are not against the mid-cap oriented funds. Instead, we want our investors to have a better understanding of plus and minus of investing in mid-cap oriented funds. And never ever get attracted by the sharp short-term gains these funds deliver, as the rise as well as fall is very sharp here. One should have the courage to hold on to them for long and should be brave-hearted to withstand big shocks. Over the long-term, large-cap oriented funds have proved to be a better investment options than the mid-caps both in terms of returns as well as volatility. However, mid-caps should not be avoided at all. Instead a small portion of mid-caps together with a higher large-cap exposure makes a healthy portfolio.