Mid-cap stocks fail to live up to their promise

Retail investors are usually partial to mid-cap stocks, a phenomenon that has not gone unnoticed by mutual fund managers, with schemes focussed on the mid-cap theme managing assets of over Rs 30,000 crore.

However, investors who bought mid-cap stocks have not really done all that well in recent years, if the performance of a broad market index of such stocks is anything to go by.

Over a five-year period, the CNX Midcap index, the benchmark index for mid-cap stocks, has managed only a 9.8 per cent compounded annual return. This barely matches the CNX Nifty. Over a three-year period, mid-caps have managed a 7 per cent return, slightly better than the Nifty; but these returns are still nothing to write home about.

Why they lagged

Why have mid-cap stocks delivered such a lacklustre performance, especially in a bull market?

To start with, it is wrong to call the recent stock market rally a ‘bull market', counters Ms Jyoti Vaswani, Chief Investment Officer and Director – Fund Management, Aviva India.

“The Sensex has delivered a negative 3 per cent return over the past three years. For mid- and small-cap stocks to outperform, you need a secular bull market. Market conditions over the last three years haven't been conducive to mid- and small-cap stocks as the risk appetite has been low globally post 2008.”

Mid-cap stocks have certainly lived up to their reputation as high-risk bets in this period, falling steeply during the 2008 market crash and in the recent correction too.

Funds struggle too

Equity mutual funds riding the mid-cap theme have struggled too. The five-year average returns of equity funds that focus on mid-cap stocks stand at a modest 7 per cent a year. Yet, equity funds with a mid-cap flavour have been quite popular with investors. There are as many as 54 specialised mid-cap funds in operation today, managing assets of Rs 33,000 crore.

Time to buy?

This constant under-performance has in fact widened the valuation gap between the blue-chips and mid-cap stocks in recent years. The Nifty has seen its price-to-earnings (PE) ratio move up from 20 times in March 2006 to 21 times now. In contrast, the CNX Midcap Index has seen its valuations plummet from 24 times in March 2006 to just 17 now.

Does this mean this is a good time to buy mid-cap stocks? Yes, but with some safeguards in place, say fund managers.

Ms Vaswani says: “Some of the valuations in the mid-cap space are very attractive, especially in the infrastructure sector. However, it may be best for retail investors to invest in mid- and small-cap stocks through the institutional route as the volatility involved is quite high and these companies need to be monitored closely.”

Warning that mid- and small-sized companies may be more vulnerable to risks of rising raw material prices or interest rates, Mr Vetri Subramaniam, Head- Equity Funds, Religare Mutual Fund, said: “There is no doubt that mid-caps are more volatile than large-caps, but the point is that they can also generate much higher returns. So investors should make sure that their allocation to mid-cap funds is capped, rather than avoiding the category altogether.”

COMMENT NOW