Wild Ride - IV

Mid-caps have been very much in the news recently and for all the right reasons. In the recent rally starting from March 9, 2009, these stock prices have hit the roof. Between March 9 and July 31, the BSE Mid-cap index delivered 118.17 per cent, as against the Sensex return of 92.03 per cent during the same period.

This was not the case a short while back. In 2008, the category, on an average, eroded 62.30 per cent of investors’ wealth, with the worst fund turning in -80.36 per cent and the best, a miserable -37.41 per cent. But even these returns were still better than the indices. The BSE Mid-cap and BSE Small Cap each delivered -66.95 per cent and -72.41 per cent, respectively.

So why is everyone buying into smaller companies’s stocks now? In 2008, liquidity vaporised from the mid- and small-cap space. Investors, including fund managers, obviously did not wish to be saddled with stocks in which they would have to make a painful exit. So these stocks were shunned. Now that liquidity has begun to come into the market, the outlook has changed.

Another reason that the comfort level with smaller companies is on the rise is because capital is not as expensive. Around October 2008, the bluest-of-blue chips were borrowing at double digit interest rates for 5-year paper. Paper was just not available for the mid- and small-cap universe resulting in an acute credit crunch in their entire business model. Now with the credit markets thawing, liquidity has been unleashed. Borrowing costs have come down for 5-year tenure and even smaller companies can now borrow at less than double digit rates.

Our Selection
There’s no denying that mid-caps offer a wild ride. Besides being volatile, they are much more risky than the staid large-caps. Yet, no serious equity market investor would avoid investing in smaller companies. The growth opportunities offered by such companies is phenomenal.

Being a risky proposition, it would be wise to opt for a mutual fund that invests in such stocks. But when selecting mid-cap funds, investors have two issues facing them. One is identifying a pure mid-cap offering. There are some funds that have a dynamic allocation in terms of market capitalisation. So it is not surprising to sometimes see them stack up on large-caps while at other times resemble mid-cap offerings.

On the other hand, every fund house will have its very own definition of what constitutes a large-cap and what constitutes a mid-cap. There is no consensus on the exact definition.

We have identified six funds that would interest the investor. And, we followed certain ground rules to help us deal with the above uncertainties. We first listed the pure mid-cap funds. We arrived at this list by selecting those funds that had invested less than 40 per cent of their assets in large-caps over the past one year (see: The Size Debate to understand our definition of various market caps). Then, by taking a historical look at their returns and risk profile, we narrowed down a list to six.

1. Birla Sun Life Mid Cap Plan A
2. ICICI Prudential Discovery
3. IDFC Premier Equity Plan A
4. Sahara Mid-Cap Fund

We will showcase a new fund, that is part of the selection, each day.

This article has appeared in the August 2009 issue of Mutual Fund Insight.