The Hindu Business Line : Mid-caps: Going beyond their face value

Contrary to the popular notion, mid-cap stocks are not instant money-spinners. They are only for the patient investor and require a fairly long investment horizon.

THE word "mid-cap" has whipped up as much investor frenzy in this bull market as the word "software" did in the previous one. Readers write in asking for the best mid-cap funds to invest in, newsletters list out "five mid-cap picks for the day", and rare is the new fund that does not reserve space for mid-cap stocks in its portfolio.

Much of this new appetite for mid-cap stocks stems from the search for multi-baggers. Trawl the vast population of "mid-cap" stocks and you have a good chance of stumbling upon the next Infosys; indeed Infosys was a mid-cap stock barely 10 years ago? Or so investors seem to think.

But for this, investors should be aware of what exactly constitutes a mid-cap stock, and what kind of strategies may pay off and what may not.

Labels don't matter: To start with, don't go merely by the mid-cap label while evaluating a stock. The term is now much abused. It may be used to describe a medium-size company with good management and growth potential. Or it may merely lend a veneer of respectability to an obscure company that will not even last, into the next bull market.

"Investors have come to view mid-caps as a genre. The moment you attach this tag to a stock, it changes the way people look at it; all they see is huge return potential" observes Mr Tridib Pathak, the Chief Investment Officer of Chola Mutual Fund.

Fund houses say that if you apply filters on management quality and business prospects, there are no more than 200-300 investment-worthy stocks in the universe of 2500 or so that trade on the bourses everyday. If you are keen on spotting emerging leaders, going by the size of a company's operations may be better than going by its market cap range; the latter is only an incidental number. It may be better to focus on mid-size companies that hope to make it to the number two or three slot in their sector. This will give much better results than zeroing in on all the stocks that have say, a less than Rs 1,000-crore market capitalisation.

Hold longer: Second, contrary to the popular notion, mid-cap stocks are not instant money-spinners. They are only for the patient investor and require a fairly long investment horizon.

Not only do you have to spot the right stock, you have to be prepared to hold it over several years and market cycles, before it turns into a multi-bagger.

This is especially true of current market conditions, where the majority of good businesses have already been unearthed and rewarded investors with high valuation multiples.

Holding a diversified portfolio of mid-cap stocks, by taking the mutual fund route, would be a good way to reduce the risks associated with mid-cap investing. But even with a mid-cap fund, a long investing horizon is a must for really good returns. If you had invested in the Franklin India Bluechip Fund, a large-cap fund, and Franklin India Prima Fund, a mid-cap fund, at the time of their launch in December 1993, returns on the Prima would have lagged those on the Bluechip until 2002. It is only over the past three years that Prima has delivered much higher returns.

What's a mid-cap stock? Even if you do plan to take the mutual fund route, acquainting yourself with the definition of mid-cap stocks is important. No two fund houses seem to agree on the definition of mid-cap stocks.

Chola Mutual Fund defines mid-cap stocks as those falling in the Rs 300-3,000 crore market cap range.

HDFC Mutual Fund believes that mid-cap stocks are those that straddle a market cap of between Rs 500 crore and Rs 2,000 crore. Fund houses such as Templeton and HSBC follow a fluid definition of mid-cap stocks that is pegged to prevailing market conditions. The boundary for what constitutes a mid-cap stock may keep shifting as the market matures. These sweeping definitions actually give considerable leeway to fund houses to pack their portfolios with whatever stocks they choose.

As a result, two mid-cap funds may have vastly different risk-return profiles. The portfolio of Sundaram Select Midcap has an average market cap of Rs 1,200 crore, whereas the number is at Rs 2,500 crore for Franklin Prima Fund.

After all, MICO (market cap Rs 7,000 crore) is likely to have a vastly different risk-return profile from Kalyani Brakes (market cap Rs 700 crore); both stocks find a place in the portfolios of mid-cap funds. Depending on their portfolio composition, funds also measure themselves against different benchmarks for their mid-cap funds.

A few use the CNX Midcap index, others stick to the broadbased S&P 500 and yet others use the Junior Nifty. Comparisons between mid-cap funds are difficult in the absence of a common definition for mid-cap stocks and a standard benchmark.

Investors can use the following metrics to select the most suitable mid-cap fund:

Don't go by the returns alone, also compare risk measures, such as the volatility of returns, before making an investment.

Check out the benchmark. A fund that compares itself to the Junior Nifty may be more suited to conservative investors than one that compares itself to the S&P 500 or the CNX Midcap index.

If you are reasonably familiar with individual stocks, run through the actual portfolio of the fund to assure yourself that the portfolio comprises good businesses.

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page