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Does your mutual fund portfolio have Ferraris? - Outside View by PersonalFN
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Does your mutual fund portfolio have Ferraris?
Apr 7, 2011

Zippiness is what we all desire when we talk about return on our investments. While many of you may think mutual funds are dull and boring as the zippiness lacks on the returns front, there is breed in them known as mid cap funds which can add that zippiness to your mutual fund portfolio. But before we go ahead in assessing how mid cap funds are capable of adding that zippiness to the return on your portfolio, let’s understand what are mid cap funds. What are mid cap funds?

Mid cap funds are those mutual fund schemes which own stocks of small and medium sized companies. While there’s no standard definition to classify a company as small and medium, generally the classification is done so on the basis of market capitalisation or the market value.

Such companies are generally established and have a potential to grow, as they are still in the growth stage of their life cycle, thus having a potential of being tomorrow’s large caps. Being small in size (as compared to large caps) they have the capability to move fast like the Ferrari car, which adds to their energy on the returns front. Being medium sized companies own by such funds, they have a leaner engine; but they are yet powerful for you to win a race.

But that also goes to say that the zippiness of a Ferrari also comes with a risk. Yes, you are right the volatility. Hence while they offer a high risk-high return investment proposition, it is imperative to assess how the driver of the Ferrari i.e. your fund manager of the mid cap fund manages that zippiness of the mid cap stocks to deliver enticing returns for you. The returns in mid cap would be dependent on how well the fund manager has played during the mid cap rallies too.

How has the BSE Mid Cap Index performed?
BSE Midcap Index
(Base Rs 10,000)
(Source: ACE MF, PersonalFN Research)

So far as depicted by the chart above, we have seen two strong upside mid cap rallies. One which started from June 2006 and lasted till the Indian equity markets were rocked by the news of the U.S. Sub-prime mortgage crisis in January 2008. And the other which began from March 2009, after the Indian equity markets recovered from the global meltdown (caused by the U.S. sub-prime mortgage crisis).

During the rally of June 2006 to January 2008, the BSE Mid Cap Index displayed its Ferrari like performance by delivering a whopping 171% returns on an absolute basis. But when the global meltdown (caused by the U.S. sub-prime mortgage crisis) did occur during the period January 8, 2008 to March 6, 2009, the same returns were eroded as the BSE MidCap Index slipped and gave a negative return of 74%. However, again during the period of recovery (i.e. from March 9, 2009 to till date) the BSE Mid Cap Index has once again accelerated by delivering a zooming returns of +155%.

Hence, in that sense the mid cap space has displayed enormous volatility which in turn makes it imperative for you to select those mid cap funds which certainly have the zippiness like a Ferrari, but also have consistency in delivering returns (the road stability like a Ferrari!).

Thus while selecting mid cap mutual fund schemes, you got to adopt enough prudence and ensure that you are investing in the right mid cap funds which follows strong investment processes and systems (just like how a Ferrari car is well-engineered!). Understanding this would enable you to judge how well your mid cap fund would perform over the long-term by identifying good robust mid cap companies having robust business models (similar to the build quality of a Ferrari!).

How mid cap funds have fared?
Scheme Name 6-Mth (%) 1-Yr (%) 3-Yr (%) 5-Yr (%) Since Inception (%) Std. Dev (%) Sharpe Ratio
ICICI Pru Discovery (G) -11.2 7.1 22.2 13.5 25.8 10.36 0.14
HDFC Mid-Cap Oppor (G) -13.1 8.9 16.6 - 9.8 9.07 0.09
IDFC Premier Equity-A (G) -16.0 8.0 15.8 20.1 22.1 9.26 0.09
Sundaram Select Midcap (G) -16.7 2.5 13.8 13.8 35.3 11.79 0.06
Reliance Growth (G) -16.0 -1.5 10.9 14.2 27.3 9.66 0.05
Franklin India Prima (G) -16.1 -1.2 9.9 5.7 20.5 10.78 0.04
Religare Mid Cap (G) -16.7 4.6 7.3 - 7.2 10.6 0.0
Kotak Midcap (G) -20.0 4.0 6.1 3.9 14.7 10.37 0.01
JM Mid Cap (G) -24.8 -12.5 5.2 1.6 12.2 10.94 0.02
Tata Mid Cap (G) -17.7 -4.5 2.9 3.4 8.4 10.21 -0.01
BNP Paribas Mid Cap Fund (G) -19.8 1.8 -1.9 - -3.4 11.30 -0.05
HSBC Midcap Equity (G) -31.2 -16.1 -1.9 -0.1 11.0 11.05 -0.04
SBI Magnum Midcap (G) -19.1 -4.6 -2.8 1.8 13.0 13.61 -0.02
Taurus Discovery (G) -25.9 -8.1 -12.5 -1.9 1.9 12.96 -0.08
BSE MIDCAP -20.2 -3.8 3.0 5.0 - 12.46 0.00
(NAV data is as on March 18, 2011. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period.
Risk-free rate is assumed to be 6.37%)(Source: ACE MF, PersonalFN Research)

The table above reveals that the performance of various mid cap funds so far has been rather mixed. There have been some mid funds which have shown the resilience and zippiness like the Ferrari car, while there are some have just displayed lacklustre returns on account of not owning good stocks with robust business models.

If assessed over a 3 Yr time frame some of them have delivered stellar returns (won the race like a Ferrari!), while some have disappointed investors by giving them a feeling of being betrayed against the promise of a Ferrari like return.

It also exhibited from the table above that mid cap funds have been typically a high risk-high return investment propositions (have zippiness like a Ferrari!). But some funds have managed their risk well by owning good stocks having robust business models (owning good engine like Ferrari!). They assume high risk as displayed by their Standard Deviation (SD), but also have deliver appealing risk-adjusted returns as revealed by their Sharpe Ratio (SR). So, there having been some good performing funds like ICICI Pru Discovery, HDFC Mid-Cap Opportunities, IDFC Premier Equity-Plan A, Reliance Growth and Franklin India Prima Fund in the mid cap space.

But, judging performance across market cycles is important

Yes analysing returns on the face of each fund is not enough! To assess whether it suits your risk appetite, you also need to recognise how mid cap funds perform on an average during various phases of the market cycles

Performance across market cycles
Schemes / Index Bull Bear Bull
14-June-06 to 09-Jan-08 to 09-Mar-09 to
09-Jan-08 09-Mar-09 18-Mar-11
Mid cap funds* 78.8 -62.5 56.4
BSE Mid cap Index 84.7 -68.4 58.8
BSE Sensex 71.6 -55.4 47.3
*Note: Average returns have been calculated of the peers above
(Source: ACE MF, PersonalFN Research)

It is exhibited from the above table that mid cap funds have underperformed the broader BSE Mid cap index during a bull run. But when compared the BSE Sensex they have certainly outperformed. Similarly during the bear phase of the equity markets mid cap funds so far on an average have fallen lesser as compared to the broader BSE Mid cap index. And in comparison to the returns of the BSE Sensex, (during the bear phase) they have taken a far more beating.

To simply put, this thus reveals that mid cap funds during the upside of the equity markets accelerate very well (like the Ferrari car!), but they don’t shy away from disappointing you during a rough patch of the equity market.

Portfolio Strategy:

However, if you pick funds which follow sound investment processes and system while selecting stocks for its portfolio, you may feel fewer jerks (during these rough patches of the equity markets) on your journey to long-term wealth creation. Hence it becomes imperative to peek into the stocks and sectors (engine of the Ferrari) which mid cap funds are expose to.

Top 10 sectors
 
Top 10 Stocks
Top 10 Stocks % of holding* 
Ipca Laboratories Ltd. 3.0
Coromandel International Ltd. 2.5
Glaxosmithkline Consumer Healthcare Ltd. 2.3
Petronet LNG Ltd. 2.1
IndusInd Bank Ltd. 1.9
Shriram Transport Finance Company Ltd. 1.7
Asian Paints Ltd. 1.6
Page Industries Ltd. 1.4
Indraprastha Gas Ltd. 1.3
United Spirits Ltd. 1.3
Note: Sector holdings as on February 28, 2011 of mid cap funds in the peer comparison
table, have been taken for top-10 sector calculation.
*Top 10 stocks are also consolidated of mid cap funds in the peer comparison table
(Source: ACE MF, PersonalFN Research)

While most mid cap funds are mandated to have a diversified equity portfolio, they dominantly capture opportunities in sectors such as displayed by the chart above; which the fund manager foresee to be promising businesses with robust business models (well engineered like the Ferrari).

In a nutshell:

While mid cap funds can certainly add zippiness to the return on your investments, you got to ensure whether you are ready to board such funds by assessing your risk appetite.

Ideally you should ascertain your risk taking ability by taking into account the factors such as your age, income, expenses, and nearness to financial goals. While allocating your investible surplus in mid caps funds, please spread it over 3-4 funds which follow strong investment processes and systems (ensure they are well engineered like the Ferrari!), rather than putting your money in one mid cap fund.

Remember mid cap funds are a good means to diversify your portfolio and add a flavour of growth when the large cap funds in your portfolio are flagging. But in order to be on the path of wealth creation, you need to invest for the long-term so that these funds with Ferrari engines can reward you well for the risk taken.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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