As the mid-cap and small-cap indices are trading at a discount to their historical averages after sharp corrections last year, you can gradually increase your investments in these two segments. Retail investors are investing in these two categories through mutual funds as mid-cap and small-cap funds saw net inflows of Rs 1,176 crore and Rs 1,378 crore respectively in November as compared with net outflows of Rs 1,039 crore from large-cap funds.
Mid-cap and small-cap stocks have gained investors’ attention over the last five years. While a large-cap stock is generally less volatile than an average small and mid-cap stock and provides stability to the portfolio, the small- and mid-cap segments often offer many opportunities to investors for potential higher growth.
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Mid-caps stocks can help in diversifying an investor’s portfolio, earn dividends and get value appreciation. As the fundamentals of the Indian economy is strong, mid-cap and even small-cap stocks will gain and the valuations have become attractive now. The Nifty Midcap 100 now trades at 23.4 times and the Nifty Smallcap 100 at 16 times.
Investors should look at mid-cap and small-cap stocks with at least a three to five years horizon because they can be very volatile in the short term. Sushil Jain, CEO of wealth management firm PersonalCFO.in, says mid-cap stocks should be held for at least five to seven years. “In the current scenario, you should be very careful while investing in small-caps. Stick to your existing small-cap allocation which is based on your risk profiling and time horizon. The investment should be for at least seven to 10 years,” he says.
Allocation to mid-cap and small-cap should be based on the time horizon and the asset allocation strategy of the investor. “The volatility in these two segments is high and investors should accordingly allocate the corpus over a horizon of five to seven years based on the past returns,” says Brijesh Damodaran, managing partner, BellWether Advisors LLP.
What to look for before investing
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The companies in these two segments are often able earn higher returns as they have the flexibility to act fast in case of an upturn or a downturn. Look at companies in mid- and small-cap segments with strong balance sheets and the quality of revenue growth. Take note of the total debt of the company and the higher free cash flow. In fact, these factors will help companies survive any business uncertainties.
While selecting a mid-cap stock, it is important to look for businesses that have high margins and have sustained margin over a period of time. Companies that have a leading position in the sector is a good bet. Take note of the management quality and ensure that it has the capability to take the company ahead and earn profit. Review the portfolio at least once in a year.
Look at mid- & small-cap funds
Ideally, invest in mid and small cap funds via the mutual fund route. You can look at two to three funds in each category based on the track record of the fund and the stock selection. Mid-cap funds have a higher growth potential than large-cap funds and strike a balance between risk and return.
A long-term systematic investment plan in mid-cap and small-cap funds can be a good investment option. In fact, mid-cap and small-cap funds have shown strong performance over the past three years with annualised returns in the range of 22%-30%, outperforming large-cap funds by a good margin.
* Hold mid- & small-cap stocks for at least three
to five years as these can be very volatile in the short term
* Ideally, invest in these stocks through the mutual fund route
* Mid-cap and small-cap funds have shown 22%-30% annualised returns over the past three years