When,Why And How Much To Invest In Mid-Cap Funds?

Mid-cap dedicated funds are one of the most battered categories in last one year, investors are in a dilemma and are confused with regard to their investment decision in mid-cap funds. DSIJ help you understand when, why and how much to invest in mid-cap funds?





Investment in mutual funds, most of the time, is driven by their past performance. Though the past performance helps in gauging the performance of the fund manager, it does not in any way indicate its future performance. This often happens in the case of mid-cap and small-cap funds as these provide exceptional returns when the market is in a bull run, but these fall equally hard when the markets enter a bear phase. So, people often wonder why should one invest in mid-cap funds in the first place? Also, they wonder about when to invest in mid-cap funds and how much to invest in mid-cap funds? Let us answer these questions one by one.

Why To Invest In Mid-Cap Funds?

If we ask you the following, what you will choose? Fund A, a large-cap fund that gave returns of 12 per cent, or Fund B, a mid-cap fund that gave returns of 18 per cent in the last five years. Surely, you will go with Fund B, the mid-cap fund. Mid-cap funds have greater potential to generate higher returns than large-cap funds in the long run. Technically speaking, mid-cap companies’ space is that space which is often less researched, therefore, it leaves a gap in valuation which, of course, would be different from its fair market value. You may find mid-cap companies to be undervalued during the bear phase. This creates an opportunity for the fund manager to generate that extra returns over and above the large-cap funds and even outperform the benchmark. However, it is to be remembered that this outperformance comes with the risk of losing money in the short term. So, the basic reason behind investing in mid-cap funds is the potential to generate exceptional alpha over the benchmark and large-cap funds. Now that you know why to invest in mid-cap funds, let us find out when to invest in mid-cap funds.

When To Invest In Mid-Cap Funds?

Since the start of 2018, equity markets have been really volatile due to global as well as domestic factors. The rise in the crude oil prices, tariff wars between the US and China, depreciation of rupee, etc. all contributed to the uncertainty in the markets. But apart from these factors, there were concerns in the minds of the investors regarding the over-valuation in the mid-cap space. This further led to the fall in the mid-cap stocks. Even the SEBI’s recategorisation circular and subsequent action by the fund houses were among the factors responsible for the correction that we saw in the mid-cap universe. So, as an investor, if you had invested in some mid-cap funds, the probability is high that your investments are in red. You are puzzled and are wondering if it was a misfortune as these funds were the best performing ones until you invested.Hence, investors are in a dilemma over the right time to invest in mid-cap funds. Historically, a sharp correction in the mid-cap space has proved to be the best time to invest inthem. Though volatility would be a part of the investment, it is important to understand that rather than timing the market, it is better to have a long-term investment horizon.




If we look at the above image of the S&P BSE Mid-Cap Index, we can see its movement since inception. If we have a closer look at the year 2008, the price range was from 2,805.33 to 10,113.06 and the volatility was around 2.53 per cent. The index fell from around 10,000 level all the way down to around 3,000, which meant a loss of almost 70 per cent in just one year and, in the same period, the mid-cap MFs on an average gave negative returns of 63.5 per cent. However, if we assume that you would have invested at around 3,000 level at the end of the year 2008, then up till now, your investment would have grown at a 30.73 per cent CAGR (Compounded Annual Growth Rate) and mid-cap dedicated MF schemes for the same period on an average gave a CAGR of 21.1 per cent. This would be the case if you had entered in the mid-cap space post a sharp correction. 

Now, let us assume that if you had invested at the peak, i.e. around the 10,000 level in January 2008, then till now, you would have earned CAGR of 7.01 per cent on your investments, despite the huge fall of 70 per cent in the same year. If we look at the average returns generated by the MFs during the same period, then we find that these funds gave a CAGR of 8.67 per cent. Therefore, volatility in mid-cap funds should not deter you from investing in them and you should start increasing your exposure after a sharp fall. This will give you better returns going ahead.

How Much To Invest In Mid-Cap Funds?

It is always advisable not to put all your eggs in one basket, i.e. diversify your portfolio as this allows you to reduce your risk to some extent. Now, if you ask how much to invest in mid-cap funds, then there is no thumb rule for this and it completely depend on person to person. It also depends on your risk profile and financial goals. Say, if you are a conservative investor, then you should refrain from investing in mid-cap funds. Rather, you should opt for investing in large-cap funds for equity exposure. If you are a moderate kind of a risk taker, then you can have around 5 per cent to a maximum of 10 per cent invested in mid-cap funds. This would help you to give your portfolio a slight boost in terms of returns. If you are an aggressive risk taker, then you can have around 30 per cent to 40 per cent exposure in mid-cap stocks. So, now the question would be: Even after being an aggressive investor, why only 30 to 40 per cent exposure? As stated earlier, do not invest all your money in a single asset--rather, it is better to diversify across different asset classes. So, it is better to invest 30 to 40 per cent in mid-cap funds and the rest in small-cap funds and a little portion in large-cap funds. Now, how much to invest also depends on the tenure for which you wish to invest. If your tenure is more, then invest more in mid-cap funds. However, if your tenure is less, then invest less in mid-cap funds. In the last three years before reaching your financial goal, invest 100 per cent in debt mutual funds. The minimum tenure that you must consider for mid-cap is 7-plus years.

Conclusion
Your investment in mid-cap funds should not be guided purely by returns. To get good returns on your investment, it is important to take into consideration the risk profile and tenure of investment, which should be actually covered in a comprehensive financial plan. So, it is recommended to have a comprehensive financial plan in place which would take care of all your personal finance issues, including proper asset allocation, periodic rebalancing and also investment in mutual funds and other avenues as required. However, if you are already having a comprehensive financial plan and you have adequately saved for all your needs, then you may grab the opportunity by investing a lump sum amount in mid-cap funds when there is a sharp correction in the markets.

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