Monday, January 9, 2017

Large-cap or mid-cap, which funds are better? Or how do you evaluate these? Click on the link below to read my article in Mid-day Gujarati edition:

The English translation is as under:

Equity funds based on market cap bias
“Do you think mid-cap funds are better than large-cap funds?” This is a regular question these days from savvy mutual fund investors. On the other hand, when I look at some other mutual fund investors, their portfolios are heavily skewed towards mid-cap funds.
This is bound to happen. The mid-cap sector and the mid-cap funds have seen a dream run in the last few years. See the numbers below:
Fund category
1 year
3 years
5 years
Large cap
6.49% p.a.
13.00% p.a.
13.41% p.a.
Mid cap
7.24% p.a.
24.20% p.a.
21.75% p.a.
The numbers are surely impressive for mid-cap funds – absolutely as well as in comparison to the large-cap funds.
It is this past performance that attracts many investors towards this sector. However, while the returns are visible, the risks are often not visible. In such a situation, investors tend to ignore the risk-return relationship, which says that in order to get higher returns, one has to be ready to take higher risks. In other words, the asset category that generates very high returns may carry higher risks.
Let us first look at what these fund categories invest into. The term “cap” in both large-cap and mid-cap is abbreviation of capitalization or market capitalization. This is the value the market has put on the entire company. In other terms, if one were to buy the whole company, the amount payable would be equivalent of the market capitalization of the company. It can be calculated by multiplying the market price per share with the number of shares issued by the company.
So the large-cap stocks are those belonging to companies with large market capitalization and mid-cap stocks are stocks of companies with mid-sized market capitalization. There are small-cap and micro-cap stocks also. The schemes get the category names based on where the money is invested, e.g. the mutual fund schemes that invest in large-cap stocks are known as large-cap funds.
As a general rule, large companies are leaders in their respective markets enjoying dominant position. Most of the times, these companies enjoy stable business conditions and are able to weather the storms better than the small and mid-sized companies. Thus, investment in such stocks turn out to be safer compared to the smaller counter-parts. At the same time, some of the small and mid-sized companies may turn out to be long-term winners and end up being large-cap and market leaders. Thus, the return potential could be immense. It is this return potential that lures investors towards such companies when the going is good. However, when the tide turns, investors tend to flock towards the safer large-caps.
The risk-return relation can be seen from the graph below:
The above graph shows performance of BSE Sensex and BSE Mid-cap indices. The former represents the large-cap stocks, whereas the latter represents mid-cap stocks.
Take a look at the years 2009, 2011, 2012 and 2014. In all these years, the indices moved more than 20% up in 2009, 2012 and 2014 and more than 20% down in 2011. These are the only years with such large movements out of the last eight years shown in the graph above.
It is interesting to note here that in each of these four years of huge movements, the mid-cap index has witnessed a bigger move compared to the large-cap index (Sensex). In other words, when the stocks went up, the mid-cap stocks posted bigger gains and when the stocks went down, these posted bigger losses in comparison to large-cap stocks.
We can easily conclude from the above that while the returns in the last few years have been high, mid-cap stocks are subject to higher risks during an individual year, or even for a longer period, sometimes.
For example, if someone invested Rs. 1,00,000 in Sensex on January 1, 2011; the value of investments would be Rs. 1,03,234 after 3 years, whereas the same amount invested in BSE mid-cap would have reduced to Rs. 85,936.
It is important for anyone to understand the risk-reward relation while considering investment in various schemes. Looking merely at the recent past performance may not be enough to take a decision.
- Amit Trivedi

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