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Small-cap funds score over mid-cap ones

We take a quick look at how the reclassification system has affected small-cap and mid-cap funds and what you should opt for


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SEBI's new norms force all mid-cap funds to stay off both large-cap stocks (the top 100) and small caps (below the top 250) and to invest at least 65 per cent of their portfolio in the 150 stocks that make up the emerging blue chips in the market. This has prompted quite a few mid-cap funds to dump their small-cap holdings in the market in recent months, adding to the price declines in these stocks.

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The tighter boundaries for mid-cap funds have both pros and cons. Investors can now be sure that funds that outperform peers in the mid-cap category are indeed doing this due to superior stock-selection skills, rather than due to excessive risk-taking by betting on small caps. But on the flip side, the limited shopping list of 150 stocks may restrict the margin of outperformance relative to mid-cap indices.

Post rejig, mid-cap category veterans such as HDFC Midcap Opportunities and Franklin India Prima have chosen to stay with their current category, falling in line with the stricter mandate. But some popular mid-cap schemes have taken a leap into other categories. Mirae Asset Emerging Bluechip has chosen to be reclassified into a large- and mid-cap fund instead of a pure mid-cap scheme. IDFC Premier Equity has repositioned itself as a multi-cap fund. Investors need to take note of such fundamental-attribute changes and switch out, if uncomfortable, when taking stock of their mid-cap funds.

Small-cap fund managers, on the other hand, have been handed a bonanza by the SEBI rejig as they can now freely roam the entire listed universe beyond the top 250 stocks to unearth under-researched or under-owned names. Moreover, with a 65 per cent allocation requirement to small caps, they can devote the remaining 35 per cent to either mid caps or large caps to manage liquidity risks. There are less than half a dozen small-cap funds with a five-year record and most of these funds have opted to stay in the same category. Some AMCs which do not have a small-cap offering are likely to fill this gap.

After these changes, existing investors in mid-cap equity funds should temper their return expectations, given their fund managers' limited leeway to venture into small caps. But they can also expect less risk and volatility. Seasoned investors looking for an aggressive, high-risk-high-return option for their portfolio should now prefer small-cap funds over mid-cap funds.

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