Mid-cap funds have put up some good numbers. As of today, the category average has been 28.55%, 49.13%, 32.38%, 22.71%, 18.23 and 22.86% over 1-, 2-, 3-, 4-, 5-, and 6-year periods respectively.
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 due their ability to make sufficient amounts of money for an investor. Unlike small-cap stocks, these companies are relatively more seasoned and stable and, unlike large caps, they have a lot of room to grow.
While having a mid-cap exposure to your portfolio is a wise move, one needs to realise that not every mid cap is a potential large cap stock.
According to a report by Amay Hattangadi and Swanand Kelkar of Morgan Stanley Investment Management, it is not only difficult to enter the elite group of large-cap companies, it is almost as difficult to remain in the group. Many stocks benefit from the adage ‘a rising tide lifts all boats’ if they are in the right sector at the right time - as has been the case with the technology sector from 1997-2000, or infrastructure related sectors from 2002-2007.
Once the tide recedes, few among the group are able to sustain the earnings trajectory or continue to maintain high stock price returns.
Here’s what their research indicated:
|
The mid caps of 2007: Where they are on March 31, 2015
|
| Sector |
Graduated to large caps |
Remained as mid caps |
Fell to small caps |
| Consumer discretionary |
3
|
2
|
4
|
| Consumer staples |
2
|
0
|
1
|
| Energy |
1
|
2
|
3
|
| Financials |
1
|
2
|
9
|
| Health Care |
3
|
3
|
0
|
| Industrials |
0
|
6
|
9
|
| Information Technology |
1
|
1
|
1
|
| Materials |
3
|
2
|
4
|
| Real Estate |
0
|
0
|
6
|
| Telecommunication Services |
0
|
0
|
2
|
| Utilities |
0
|
0
|
2
|
| Total |
14
|
18
|
41
|
Large Caps > $5 billion, Mid Caps $2-5 billion, Small Caps < $2 billion / Source: Bloomberg, Motilal Oswal Research
Scouting for mid caps is no easy task. 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.
It is for this reason that we suggest that the best route for a mid-cap exposure is a specific mid-cap fund. There are numerous funds in the market from which you can choose from. Go for one that has been a consistent performer. A chart topper today will not necessarily continue to be one, but has the fund always been a top quartile performer? Or does it drop to the bottom and then gallop right to the top? How hard does it fall in bear markets and how does it fare in bull runs? Don't opt for a very volatile fund even if its performance is currently amazing.
Once invested, 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.
Even if you follow the above, investment in a mid-cap fund is more volatile than a large-cap or flexi-cap fund, generally speaking. 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. Moreover, ownership is low. Mid caps tend to be under owned by foreign and domestic institutional players, making them less liquid. 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.
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.
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 and the time period towards your goal. If you are decades away from retirement, then you certainly should have an exposure to a good mid-cap fund.
