Mutual Funds

A mid-cap dose is what the investor needs

Manish Gunwani | Updated on November 08, 2020

Mid-caps are not just cyclical bets but worth investing for wealth creation for long term

It has always been said that when the market is volatile one should stick to fundamentally strong large-caps and stay away from mid-caps, which have a higher risk-reward ratio.

However, it is time now to look at the wider universe of non-large-cap stocks and identify the potential outliers that will help create wealth in the long term.

Case for smaller stocks

A case in point is the long-term total return data for three large regions over the last 20 years.

In the US, the mid-cap index (Russell 2000) is up 3.24 times while the Dow Jones is up 3.08 times. In the UK, the FTSE 100 is up 0.7 times while the FTSE 250, which has smaller companies, is up 3.5 times. In India, the Sensex is up 13.5 times while the broader BSE 500 index is up 15.4 times.

Yes, in the last five years, large-caps have outperformed the smaller stocks globally. However, we believe this is a cycle which is likely to reverse soon.

In India, one of the key reasons for the outperformance of the larger stocks has been that economic growth — both global and domestic — has been weak relative to the long-term trend. There are promising signs that growth is likely to pick up from here. Smaller companies tend to have more opportunities for growth due to a lot of pent-up demand

Interestingly, due to the very fact that the last two quarters have been really cruel for India Inc, many of the fundamentally strong mid-cap stocks are currently available at attractive valuations.

Yes, the risk of a correction is looming large. There is a second wave of Covid-19 hitting Europe.

The Group of 20 nations were forced to extend their debt relief programme for poor countries.

The OPEC has already stated that the proposed increase in production scheduled from January may be put on hold.

Buying opportunity

However, many global investors believe that any correction in the Indian markets should be looked upon as a buying opportunity.

Thus, there is clearly a case that mid-caps are not cyclical bets but worth investing for long-term wealth creation.

Since the last three years have been tough, valuations are attractive and prospects of healthy returns are strong.

While choosing mid-caps this is a good checklist: a) the business should have a healthy return on capital at a minimum of 15 per cent b) the business should not have technological or regulatory threats, which can derail it in the medium to long term c) management should have a strong track record of execution and capital allocation.

The writer is CIO - Equity Investments, Nippon India Mutual Fund

Published on November 08, 2020

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