Mid-cap funds have put up some good numbers. Not surprisingly. Mid caps rarely fail to capture investors’ fancy during surging markets. This trend remains unbroken in the recent market rally as well. But investors should remember that the party will not last forever. And eventually, not all mid caps are tomorrow's large caps. Here's is what every mid-cap investor should keep in mind.
1) Mid caps have a lot going for them
Golfers refer to the "sweet spot" as the position on the face of the club head that when hit produces the maximum result. Mid caps are described by many as the investment sweet spot. Unlike small-cap stocks, these companies are relatively more seasoned and stable and, unlike large caps, they have a lot of room to grow. Hence, the ability to make a sufficient amount of money is evident.
Moreover, mid caps are available across sectors; and there are cyclical as well as non-cyclical mid caps. A cyclical stock is highly correlated to the overall economic activity and climate. When the economy is in a recession, profits dip and so does its share price. The converse is true when the economy is on a roll. Automobiles and metal stocks are examples. A defensive, or non-cyclical, stock shares a very low correlation to economic activity. No matter how the economy is faring, revenues and cash flows of the company remain relatively stable. Healthcare, pharma and consumer stocks are examples.
2) Don't let extreme performance faze you
Mid caps tend to scare investors because of their inherent volatility. In a bull market, they can be highly rewarding. But the fall can be steep during market upheavals.
A trait about mid caps is that the information is somewhat more limited as such stocks are not as well researched as large-cap stocks. Often, mid-cap companies have somewhat untested business models and the information available on them in the public domain is not immense. Moreover ownership is low. Mid caps tend to be under owned by foreign and domestic institutional players, making them less liquid. These factors make them high risk investment avenues.
So during downturns, when everyone flees to the safety of large caps, mid caps are dumped triggering a further fall in their price. Conversely, when markets are skyrocketing, they are once again loved in anticipation of higher returns and their prices rise faster.
Lesson to be learnt: Don't panic when they dip. Just stay put and ride the storm.
3) Be smart in your allocation
All mid caps are not equal. Investors are known to lose money by investing wrongly. However, if you are labouring under the notion that all are speculative bets, you are wrong. Some mid-cap stocks display some impressive traits that an equity investor should look at - market leader, good balance sheet, competitive advantage, great management skills and entrepreneurship, ability to manage scale, and so on and so forth.
As an investor, it would be wise to have some portion of your portfolio assigned to mid caps. How much will purely depend on your risk-taking capability. As mentioned earlier, mid caps are inherently a risky investment avenue and require investors to have the stomach to digest the higher volatility that comes along with the turf. If volatility gives you sleepless nights, then maybe you should bypass this investment option. If you are not fazed too much by the ups and downs, then the next step would be deciding how much of your equity allocation should be directed towards mid caps.
4) Opt for the mutual fund route
A secular bull run has the uncanny tendency to make a dud appear to be a great investment bet. Such instances are all the more evident in the mid-cap realm. But as we all know, all mid caps are not investment worthy and scouting for the right one is no easy task either. In fact, picking an investment worthy mid cap is far more cumbersome and complicated than is widely assumed. And compelling investment proposition notwithstanding, doing so at the right valuation is the next step.
The point being made is that it is very difficult for a lay investor to hunt down mid caps that will end up as wealth creators. If you as an investor want to expose your portfolio to mid caps, the best route to opt for is a specific mid-cap fund. There are numerous funds in the market from which you can choose from. Look at consistency of performance vis-a-vis its peers. How hard it falls in bear markets and how it fares in bull runs. Don't opt for a very volatile fund.
When investing in mid caps, stick to professionals who follow a research-driven approach.
Keep tabs on the fund you have invested in. For instance, the fund manager could change and you may not be sure if the new hand is a mid-cap expert. Or, the reason for buying the investment no longer exists. For instance, the fund manager has begun to pack his portfolio with a significant amount of large caps. This defeats the purpose of an investor who bought the fund for a specific mid-cap exposure. In such a case, he may need to sell the incumbent mid-cap fund and invest in another to restore his original balance of styles.
5) Be patient
Mid caps test investors’ patience, and very often for fairly long periods of time. On the other hand, the spurts in the performance of the share price could entice investors to redeem their investment. If you need the money, go ahead. If not, hang on. After all you invested in such a stock or fund to watch your money grow. Remember, ultimately you are investing in businesses and that takes years to expand and grow.
Whether your investment could be facing a prolonged period of underperformance or is on a sudden roll, the key is patience. Don't sell. Mid caps will deliver only over extended time frames. Many companies in this space are still evolving and their gestation period is usually high. Naturally, it would take a while for their true value to get unlocked. Be willing to commit yourself to a minimum 5 years. Though in reality, the investment horizon could be even higher depending on how the fundamentals and broader economic situation pan out.
