Mid-cap companies are typically defined as those with a market capitalization of between Rs. 500 crore and Rs. 2,000 crores. They are often seen as being more growth-oriented than large-cap companies and offer the potential for higher returns.
Mid-cap funds can be a good option for investors who are looking for exposure to the growth potential of mid-sized companies. However, it is important to remember that mid-cap funds are more volatile than large-cap funds, and investors should be prepared for the possibility of higher. Read on to find out more.
Mid cap funds – An overview
Mid cap funds invest predominantly in mid-sized companies with a market capitalization between Rs 5000 crores to Rs 20,000 crores. They form the bridge between small caps and large caps, and aim to capture the high growth potential of mid-sized firms. SEBI mandates mid cap funds to invest a minimum of 65% in mid-cap stocks.
Spotting the hidden gems
The mid cap universe tends to be under-researched compared to large caps. This allows fund managers to spot high quality businesses that may be undiscovered or undervalued. Through strong fundamentals analysis, they can pick firms with sustainable competitive advantages, scalable business models and quality management that are on the cusp of rapid growth. Mid cap investing is about finding these hidden gems before the market catches on.
Higher growth potential
Mid cap companies are in the emerging phase of growth and expansion. Compared to large caps, mid caps have higher revenue and earnings growth rates. This is driven by factors like growing market share, new product launches, expanding distribution reach, financial leverage and operating leverage benefits. Mid cap funds aim to harness this higher growth potential.
Why mid-caps outperform over the long term
Over the past 15 years, mid cap funds have delivered around 5% higher CAGR returns compared to large cap funds. This outperformance can be attributed to:
- Higher earnings growth: Mid caps demonstrate faster growth in profits.
- Opportunity to multiply over long term: Mid caps have potential to become large caps.
- Less ownership: Lesser researched segment, providing opportunity to discover hidden gems.
- Lower valuations: Mid caps tend to trade at lower P/E and P/B compared to large caps.
Selecting the right mid cap fund
Consider these aspects while selecting a mid cap fund:
- Fund manager’s experience in mid cap investing.
- Consistent long term performance across market cycles.
- Stock selection process focusing on sustainable growth.
- Reasonable concentration in top 10-15 stocks.
- High active share indicating differentiation from benchmark.
- Low churn indicating conviction-based investing.
Risks to consider
While mid caps offer higher return potential, they also carry some key risks:
- Higher volatility compared to large caps.
- Vulnerable to market downturns and liquidity crisis.
- Corporate governance concerns in some mid caps.
- Lack of analyst coverage and lower liquidity.
Mid cap allocation for your portfolio
Consider allocating 15%-25% of your equity portfolio to mid cap funds for diversification and to benefit from the long term growth potential. Balance the higher returns potential with the volatility risks based on your risk appetite and investment horizon. As part of the core and satellite approach, use mid cap funds as satellite investments to complement large cap core holdings.
Conclusion
Mid cap funds offer a compelling opportunity to tap into the higher growth potential of emerging firms. They could prove to be multi-baggers over time as undiscovered gems become established businesses. However, balance risks and have reasonable return expectations. Take a long term view and avoid timing the market.