Mid cap funds offer relatively greater stability than small cap funds, but less than that offered by large cap funds.
As per SEBI’s new guidelines effective from October 2017, mid cap funds are funds which invest in mid-sized companies. These are defined as those companies which rank from 101 – 250 in terms of market capitalisation. The returns offered by mid cap companies have been stellar over longer time-frames. These funds help in generating ‘Alpha’ for a portfolio and have been good options both from a diversification and wealth creation point of view.
Mid-sized companies are literally in the ‘middle’ of growth trajectory. These companies have graduated from being small caps and thus they can withstand the challenges posed by market cycles to a higher degree than their small cap counterparts. They are waiting to take the next leap and thus their growth potential in a market uptrend and economic revival is quite high. A good mid cap company’s transformation into a large cap can be very quick as the markets give it the benefit of aggressive growth, earnings and revision in ratings.
That being said, mid cap funds are still governed by the market and have a certain degree of risk hence. Mid cap funds offer relatively greater stability than small cap funds, but less than that offered by large cap funds. Equity markets work in cycles and stocks usually go up and down in tandem with these movements. Mid cap stocks go down at a higher pace in case of a market slide, although they are considered to be rewarding when markets are trading higher. Let’s see what all should you look at while you select mid cap funds for your portfolio.
To check the performance record, the first thing to look for are the rolling returns across 1 year, 3 year and 5 year mark. The performance has to be analysed for consistency across different phases of the market cycle . You must understand the risk and return metrics with respect to the benchmark Index to gauge the returns from the fund you want to invest in. To do so, take a look at certain quantitative metrics while shortlisting funds. These include various risk reward ratios such as alpha, sharpe ratio, standard deviation etc. Alpha refers to return generated by a scheme over and above the return provided by the markets/ benchmark. This highlights the skills and strategies adopted by the fund manager. Benchmark acts as a standard for a fund’s performance measurement.
Alpha should be higher than the expense ratio as this is the return that will be provided to the investors. Similarly, the Sharpe ratio measures the return per unit of risk generated by the fund. The ratio again should be higher than the benchmark as well as other funds in the category.The fund that has performed well despite a market downturn should be considered seriously.
Expense ratio is an important criterion because over a long period of time, the expenses can eat into the returns and lower the overall corpus. However, along with a lower expense ratio, you should focus more on selecting good schemes with a track record and strong management. A poor scheme with below par performance but a slightly better expense ratio will not make a difference to the investment portfolio.
Quality of Fund House
Mid cap stock selection requires a high degree of research. A fund house with a strong and considerably long and proven track record is a better bet for investors. The funds would have gone through multiple market cycles and thus the fund manager would be in a better position to tackle the market volatility. An experienced management team and a pedigreed fund house can thus make a marked difference in fund returns.
You can use any online investment online that allows you to compare funds of the same category to assess their performance against benchmark and against each other. Accordingly, you can make informed decisions. However, whether it is mid cap funds or any other, make sure the fund category you choose is congruent with the goals you want to achieve within the specific time horizon, your risk profile and asset allocation strategy.
(By Harsh Jain, Co-founder and COO, Groww)