HDFC Small and Mid Cap: Sell

Even as many quality mid and small-cap funds set the returns chart ablaze over the past three years, there are others that have fallen way behind top performers. In this regard, investors can exit the units of HDFC Small and Mid Cap in the light of its sub-par performance across time frames.

For the record, the fund has managed to do better than its benchmark, the CNX Small Cap index, over three and five-year time frames, while falling behind in the last one year.

That the fund has underperformed even its benchmark in the one-year period is especially disappointing as it was a market where mid and small-cap stocks were the rage.

The fund has vastly underperformed peers in its category and has been in the bottom quartile of funds in its category across one, three and five-year periods. HDFC Small and Mid Cap delivered 24 per cent and 14 per cent returns over three and five-year periods, respectively, on an annual basis. This is a good 6-8 percentage points lower than the category and a good 10-15 percentage points lower than the best performing funds.

This underperformance, coupled with a mixed portfolio which is not in sync with a normal mid and small-cap fund, may offer reason enough to exit.

Investors could switch over to HDFC Mid-cap Opportunities, which has delivered top-notch performance over the years.

Despite having a mandate to invest in small and mid-cap stocks, HDFC Small and Mid Cap also invests a substantial portion of its corpus in large-caps.

The fund generally invests only 40-60 per cent of its corpus in mid and small-cap stocks. Their proportion has risen to 60 per cent in the last one year.

In early 2013, the fund had more than 80 per cent of its portfolio in large-caps.

This partly explains why the fund lagged behind peers over the past several years even as mid-caps rallied spectacularly. Its current portfolio does have 30 per cent invested in small-cap stocks (less than ₹5,000 crore market capitalisation).

But despite this allocation, the fund continues to underperform.

It also takes cash exposure to the tune of 6-11 per cent, which pulls down performance when markets are on an upswing.

Over the last couple of years, the fund bet excessively on the software sector. There has been heavy underperformance in this sector, especially from the larger companies to which the fund took exposure. Banks remain the top bet.

But low bets on segments such as industrials and auto over the past couple of years meant that it was not able to participate in the rallies that these segments witnessed.