The Hindu Business Line : Fund Talk

Is this the right time to invest in mid-cap funds? Please suggest some good mid-cap funds for investment in the present context. Top-rated mid-cap funds, such as Magnum Global, Sundaram Select Midcap and Franklin India Prima, are not doing well at present. Moreover, which is the better option today — large-cap, mid-cap or flexi-cap funds? Please advise.

S. K. Sharma

If you really wanted to time your entry into mid-cap funds perfectly, March 2007 may have been the right month to do it. The appreciation in select mid-cap stocks since March has tended to narrow the valuation discount between large-cap and mid-cap stocks. Between March and now, the price earnings multiple for the CNX Mid-cap index has improved from about 14.8 times to about 17 times earnings. However, switching your allocations between mid and large cap stocks is a difficult strategy to practise.

Admittedly, mid-cap and large-cap stocks do tend to outperform each other in cycles, over different periods of time. However, predicting such periods of out-performance in advance and switching allocations in time to capture the out-performance can be a very difficult strategy to implement. This is why we think that identifying flexicap funds with a good long-term track record and staying with them over several years, may be the best option for investors who would like to benefit from exposure to mid-cap stocks.

When you invest in flexicap funds, you can leave the re-allocation process to the fund manager, while at the same time saving on the transaction costs and taxes that are bound to accompany a high-churn strategy. Among the various funds that offer a mix between mid- and large-cap stocks, HDFC Equity, Magnum Multiplier Plus and Franklin Flexicap are some funds you could consider.

As to the performance of mid-cap funds, you haven't mentioned the time-frame over which you have tracked their returns. If you are referring to the returns for one year, they are quite unimpressive, with most funds in the category reporting marginally negative or single-digit returns, at a time when most large-cap-oriented funds have done much better. However, this is largely reflective of the performance of mid-cap stocks as a genre.

One-year returns on the CNX Mid-cap index hover at just about 2 per cent, while the Nifty, which represents large cap stocks, has generated 12 per cent over the same period. You should bear in mind that even the best performing mid-cap fund will only track the performance of the category and cannot do much better than that while sticking to its mandate.

In our view, to really reap the benefits of mid-cap investing, an investor needs to stay invested at least for a five-year time-frame. Bulk of the value unlocking in a smaller company happens only when it scales up operations and has proved its ability to manage growth and size; this usually takes considerable time.

Liquidity issues associated with mid-cap stocks also make them more suitable to long term investors who can buy and hold rather than short-term investors. The performance of mid-cap oriented funds such as Magnum Global or a Franklin India Prima over a five-year time-frame bears this out, with the funds managing a six- to seven-fold appreciation in NAVs over a five-year period.

Aarati Krishnan

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