Risks and potential of Mid-cap Mutual Fund schemes

The returns in the mid-cap mutual fund schemes have been badly hit in the recent stock market meltdown. However, the impact has not been the same across all the funds in the category. The 1-year return on some funds is close to 12 percent while many others are still down by almost 17 percent.

This means, the choice of the right mid-cap scheme is important rather than investing only in the current performer. Interestingly, the average 10- year return is about 12 percent for the category which shows that one needs to invest in these schemes for the long term.

Mid-cap funds are riskier than large caps as they invest in relatively smaller companies, which are in the growth stage and generally under-researched. Once these companies grow in size, they are recognized by the market and enjoy better valuations. 

This category of fund aims to gain from the change in valuation that happens when a small-cap company becomes a mid-cap company, which then grows to become a large-cap company. 

So, these funds diversify across companies that are on a fast-growth trajectory. Mid-sized companies have more scope to expand relative to their counterparts that have already been through the rapid growth phase. As such funds venture into the relative unknown, the risk-reward ratio is higher.

The mid- and small-cap segment is a good investment opportunity for long-term investors who have considered both the returns and the risks. Before you decide to invest in a mid-cap fund, remember that it cannot form the foundation of your portfolio. It should be included only to the extent permitted by your risk profile in order to enhance the returns.

The return potential of mid-cap stocks is perceived to be more than other stocks in the long run. After all, successful mid-cap companies are those who are considered to deliver consistent performance over a longer time frame.

As an investor, remember that mid-cap funds invest in mid-cap stocks and hence don’t go by the reputation or the market perception of a company. Rather, look at its market capitalization as they are not among the top 100 companies in terms of market capitalization. 

As per SEBI, 101st to 250th company in terms of market capitalization are defined as mid-cap companies and mid-cap funds invest a minimum of 65 percent of their assets in these companies.

There could be periods in-between where the mid-cap funds may outperform large caps. Between August 2015 and August 2018, mid-caps performed while the large caps gave muted returns. Such periods will keep coming on and off and therefore one needs to remain invested for long to reap the benefits over the long term.

As it goes for every MF, do not consider the short-term performance. The reason is that a longer-term performance will show how consistent has the fund been over a longer time frame and across different market cycles. Assess the performance of the funds during good and bad market cycles and then decide. 

One may also consider looking at the risk-adjusted ratio of the funds, better the ratios better the fund is from an investment perspective. A better way to evaluate the fund manager’s ability to ride the storm over longer periods is to consider the fund’s long-term performance against its benchmark.

While the return potential can be huge over the long term, the risk is equally high in mid-cap funds. The NAVs may fall considerably over the short-medium term. Hence, evaluate one’s risk profile before investing in them. The high performance of funds may change over time. The top funds may not remain in the top quartile always. Even if you are investing in them, diversify across 1-2 mid-cap schemes and ensure they have varying sector allocation. And, most importantly, mid-cap funds do not make up the core of your investment portfolio.

Conclusion: 

Mid Cap Mutual Funds invest in the mid cap companies with higher growth potential and have the potential to offer higher returns than large caps without being risky like small cap funds. 

Mid-cap stocks take time to become market favorite. But, when they are identified by market participants as potential winner of tomorrow, the investors can expect gains. Link the investments in mid-cap schemes to your long term goals for better results.

Author: Sanjeev Puri

Published: Investors India Magazine, August 2020 Edition