Anoop Bhaskar on investing in mid caps

By Morningstar |  23-12-15

Going forward, do you see a lot of money flowing into the mid- and small-cap space?

There has been fair bit of optimism that we will crank up our economic growth by several notches and historically in such phases, mid and small caps have done well. People go by patterns and that is a pattern that everyone believes is going to repeat itself.

I would stress that it's more a question of what kind of asset allocation that you have in investors' portfolio that matters rather than what are the valuations in this segment, and also the temperament.

It's easy to sell a fund with a trailing 12-month return of 60% because that 1-year return  will make the 1-, 3-, and 5-year returns fairly solid. It's the easiest sell to make.

If you want someone to come into equities and you have this performance in the mid-cap fund, which was the case last year for a lot of these funds, you could get a lot of flows.

But if you look historically over a longer term, the ability to generate alpha is significantly higher in the mid- and small-cap space versus the large- and large/mid-cap-space, mainly because of research coverage not being there.

So, if you were to look at the median return of a mid-cap fund over a 10-year period, it generates alpha of 300% over the BSE 100. Whereas when you do it for the large or large/ mid-cap funds, that alpha is around 90-91%.

While there is greater potential, it has to be seen in the context of volatility also being much higher. It's not one side of the equation that you look at and forget the other.

There is always an element for you to discover new stocks and newer ideas which are far more in the mid- and small-cap space, but it also has a factor which people don't focus on - that the volatility is much higher. By volatility, I don't mean losing capital, but in terms of price movement. It is fairly high you need to have the temperament to sustain that.

So, if you take asset allocation as a balanced diet, then treat mid and small caps as dessert. You can sometimes have dessert as your main meal, but to stay healthy you have to limit that in your diet.

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