The year 2007 was one of the mid- and small-caps. Mid-caps in particular played a major role in elevating the Sensex beyond the majestic 20,000 mark. In 2007, the Sensex gained a tad over 47%, the BSE Mid Cap index garnered returns worth almost 69% and the BSE Small Cap index surged ahead by a whopping 93.6%. No doubt then that the year belonged to the mid- and small-caps. The mid- and small-cap funds also benefited from this rally, easily outperforming their larger peers. Reliance Growth benefited the most; it witnessed a 100% increase in its AUM. Mid-cap stocks were raked up by fund managers of equity-diversified funds as well. But are mid-cap funds really worth their while? Let?s analyse their category to answer this. Seventy-four funds had maintained an average mid- and small-cap exposure of over 50% in the past year (February 2007 – January 2008).
Out of these 74, we selected 20 top rated funds (5, 4, and 3 star). The average return of these funds was a little over 32%. Tapping the hidden potential of mid-cap shares is not easy. These stocks tend to rise and fall in very short spans of time. They may touch new heights and then within days, tumble down without notice. The recent market correction clearly illustrates the risk associated with mid-caps. When the markets started to decline on January 8, 2008, it was the BSE Mid Cap and Small Cap indices that took the beating by losing 30.7 and 37.8% respectively, compared to Sensex?s loss of 23.5% (January 8 – March 7, 2008). Mid-cap funds lost heavily too. Sundaram Select Midcap had returned 63.14% in 2007 but the fund has lost over 30% in a short span (January 1 – March 7, 2008). Investing in mid-caps is hence an ideal option only for long-term investors. And by long term, we mean at least 5-7 years. Such a time frame would give emerging companies enough time to establish themselves. However, if you still wish to capitalise on those glamourous returns of mid-cap funds and are ready to take that extra bit of risk, there are some things to be kept in mind.
Firstly, do not get fascinated just by a fund?s return during the bull-run. Look closely at how the fund did when the markets fell. And secondly, it is very important to see the overall capitalisation tilt of your portfolio. It is not that diversified funds do not invest in mid-caps. A well-rated diversified equity fund like HDFC Equity has 48% of its assets in mid-caps (as per the January portfolio). So adding a pure mid-cap fund to a portfolio, which consists of such a fund can skew the portfolio heavily towards mid-caps. In a nutshell, mid-cap funds are riskier options compared to diversified equity funds. They are certainly not for the risk averse. Here is a view on some of the proven mid-cap funds.
The author is CEO, Value Research
Birla Midcap: Star studded
It?s tough to nail down this one?s style. Consider this. The fund invests aggressively in small companies, but ensures that a larger part of its portfolio is invested in relatively bigger mid-caps. At Rs 4,991 crore, the weighted average market capitalisation of its portfolio is pretty high. The fund manager doesn?t churn the portfolio considerably and frequently tries out new stocks. He brazenly sticks to his convictions and goes against the herd, as suggested by some of his sector bets. Yet he walks down the path of high diversification. His portfolio now has 55 stocks, up from the earlier 40-45 range. As per the February portfolio, none of the stocks account for more than 4.3% of the assets. But going by the fine numbers he has been putting in, there?s reason to think he knows what he is doing. Over the last three years, Birla Mid Cap has delivered an annualised return of 35.45% (as on March 12, 2008). It has never fallen below a four-star rating in its 24-month rating history. The fund?s return in stood at 78.08%.
Being quite small vis-?-vis other mid-cap funds, it is a nimble offering with just Rs 745 crore. The increase in corpus over the past 12 months (from Rs 228 crore) is one of the reasons for the portfolio diversification. In a nutshell, the fund does not display characteristics of being highly aggressive, especially given the amount of diversification and the kind of mid-caps it invests in. This is probably as safe as you can get with a mid-cap fund.
Magnum Global: Trend spotter
It?s hard to know what to do with this fund. From a fairly dismal track record, it was the best performer in 2004 and the second best in 2005. But in last year, the fund struggled to live up to its standard and could not match up to the peers? performance. With increased diversification, low concentration levels, and huge asset base, this mid-cap fund is in uncharted territory. From a large-cap bias, it began to aggressively invest in mid- and small-cap stocks in 2004. The move paid rich dividends. The fund?s strength has been its ability to pick trends, invest aggressively, and ride through the momentum to make huge gains. So while other fund managers balked at dabbling in real estate plays during their high rise in 2006, this one caught on to Ansal Properties and Infrastructure aggressively. And it was handsomely rewarded for its courage. Some of its picks that worked in 2006 include Dishman Pharmaceuticals, Sintex Industries, India Cements, Infotech Enterprises, and JP Associates. Compared to its earlier average of 50 shares in 2006, the portfolio now maintains an average of 67 stocks in the portfolio, none of which account for more than 5.3%. This could be the fall-out of its large asset base, which has crossed Rs 1,700 crore. Its five-year returns of 62.59% (annualised) rank it way ahead of the category?s 46.72% (as on March 12, 2008). But its year-to-date and one-year returns are quite below the category average.
Though we still think it?s a keeper, potential investors may want to wait for signs of improvement after its dismal performance in 2007.
Reliance Growth: Sizeable growth
Reliance Growth has not only emerged as the largest mid-cap fund but is also the largest equity diversified fund with AUM of over Rs 5,600 crore. The fund has been able to generate investor interest due to its impressive performance by beating its peers by an impressive margin for the past so many years. After the 2001 dotcom crash, the fund made a smart comeback in 2002 with a return of 55.75%, the second-best among the 59 funds. Since then it maintained a top quartile position for the next four calendar years. However, in 2006 the fund was ranked 53 among 145 funds with a return of 41%. In 2007, the fund?s investors had a reason to cheer since the fund gave them a high return of over 76% in the year, consequently taking the fund?s rank to 25 among the 162 funds. While the fund?s allocation to large-, mid-, and small-caps keep oscillating, during the past six months, the exposure to mid-cap stocks has increased from 43% to over 50%. In the past, the fund followed a strategy of buy-and-hold for some stocks, while in some it has gone for a quick profit taking. It is well known for its smart moves.
In February 2006, the fund maintained highest exposure to technology and basic/engineering. Now the energy and financial services sectors command the highest exposure of the fund. Over the past one year, the fund has also pared its exposure to auto and basic/ engineering sectors. However, being a mid-cap fund, the fund?s huge asset size can be a matter of concern. As of now, the fund boasts of one of the most enviable performance records even with its swelling size. But it remains to be seen whether it can continue to do so.
Sundaram BNP Paribas Select Midcap: Swift moves
This fund has clearly been one of stars of the recent bull-run in the mid-cap world in 2007. Launched in July 2002, the timing was perfect for Sundaram BNP Paribas Select Midcap. As the mid-caps started gaining momentum on the bourses in 2003, this fund brought home handsome gains for investors.
The mid-cap space slowed in 2004 and so did Sundaram Midcap?s returns. But the fund still managed to do well in 2006 and emerged as the second-best equity fund with returns of 60.77% the category of diversified equity funds. The phenomenal returns have brought in huge investor interest in the fund and assets have grown exponentially from Rs 500 crore in January 2006 to Rs 2,013 crore at present. However in 2007, the asset growth remained stagnant.
The year-to-date return of Sundaram BNP Paribas Select Midcap may not be appealing, as the mid-cap stocks faced heat on the bourses in the recent market meltdown. The fund used to keep a substantial portion of its portfolio in cash (almost 20-30 per cent). But off late, since May 2007, the fund has maintained a meager average cash allocation of 3.6%. Although the assets in cash remain unutilised, the fund uses the cash for value buying during market falls. Holdings like Lakshmi Machine Works, Thermax, IVRCL Infrastructures have done wonders. Over the past five months, the fund has decreased its holdings in the technology and the construction sector. The fund has been bullish on the financial services sector and it now accounts for 15.85% of the assets.