Funds that survived the mid-cap carnage

Kaustubh Belapurkar of Morningstar Investment Adviser spoke to ET Now on mid- and small-cap funds. The original post can be read here. Below is an extract.

Kaustubh’s advice to investors: Large caps form the core part of the portfolio. Mid and small caps are the growth driver which you buy and forget for the next 10 to 15 years.

In this mid-cap carnage, which are the funds that have stood resilient and which are the ones which are going down?

We have seen a fair bit of drawdown on the midcap indices this year but over the long term (3 and 5 years), a lot of funds have stood rock solid; from fund houses like HDFC, DSP, L&T, Kotak and Franklin Templeton. The funds that have done extremely well during this period of time. They have been in some of the stocks that did not correct as much or actually appreciated during this time.

In the midcap index, the divergence of returns is massive. While some have fallen 60% in a short period of time, some are actually up 40% in the similar period.

Which are the holdings giving that kind of stark underperformance?

Banking stocks like Bank of India and Union Bank, for instance.

Would you have a list of funds which are underperforming?

There are a bunch of names that have probably fallen off 15% which is in line with the index, but I prefer taking a long term basis. Funds will go through periods of underperformance where stocks which ran up sharply in 2017 are now down because the valuation has corrected. But that does not necessarily mean that the fund has become a bad fund.

Going forward, where exactly do you think the funds in the mid and small caps spectrum, that should be poised to be able to deliver well? Should one invest in growth funds?

In the mid and small cap segment, I would park a lot of my money in funds where most of the managers follow a growth style. These are stocks that are expected to grow at significant rates over the next 5 to 10 years and that is where the managers are really betting.

It is not really too much of a value play in this segment. There could be some value plays where some negative news has really brought a stock down but largely you would see that you are looking at large growth numbers coming from these stocks. That is why managers are betting on a 5 to 10-year cycle on these stocks.

Any themes?

Some of the trends that we have seen in Materials, Cement and Paints. Consumer cyclicals, some of the auto ancillary companies or leisure companies are some of the trends that are catching up.

The latest trend is some of the mid-tier IT companies which have appreciated. One sees manager interest in MindTree, Cyant and a couple of other names.

It is an interesting mix but growth is going to be the primary parameter when you are looking at it.

Have you seen a dramatic shift in how funds are approaching small and mid-caps? Are you seeing some of the hybrid variety or multicap funds reduce their exposure drastically or are you seeing that within small and mid-caps, they are shifting from one end of the curve to maybe the other IT, Pharma or whatever?

One thing that has happened is clearly with regards to valuations. The way they had run up, managers became even more stock specific in the small and midcap space. They do have some leeway in buying largecaps. You want to pad that up with some largecap names just to provide some more liquidity in your portfolio.  So, it is not a large shift but there is some shift happening there.

Second, is the regulator forced move where SEBI has come and said that if you are a smallcap fund you need to hold at least 65% of your portfolio into smallcap stocks and ditto for midcap funds. They have been realigning the portfolio over the last couple of quarters to get in line with the regulator mandate and move. So you have seen them becoming more pure small and midcap funds and taking a much more measured approach when getting into some of these counters.

In terms of sectors, IT is one of the counters where we have seen some additions on the midcap counter other than obviously the larger ones and the other parts of the market.

Which themes or sectors has seen money move out of?

The focus has moved away from Financials, especially in this counter. This is because most of the street prefers some of the large banks and larger financial services companies, the safer guys.