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Should You Invest In Midcap Funds Now? - Outside View by PersonalFN

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Should You Invest In Midcap Funds Now?
Aug 3, 2015

Contribution of legendary investors such as Benjamin Graham, Warren Buffet and John Templeton has been significant in the world of investing. Their success stories are an inspiration for many. People get enthused when they read how Warrant Buffet invested in companies such as Coca Cola when they were small, but growing at a rapid pace. Naturally, you feel like mimicking these legends and wish cherry picking companies as these investors did.

More often, fast growing companies are mid-sized and less researched. Their stock prices fluctuate more than those of stable companies. Investing in midcaps requires you to have an astute sense of understanding of the business of the company and have the stomach to bear high volatility associated with them. You hear a lot about midcap stories when markets are in a phase of exuberance and high valuations in largecaps sustain for long.

As in case of India today, optimistic outlook on the growth prospects of Indian economy is driving up markets and valuations are getting expensive. It is believed that, corporate performance has bottomed out already and we may see revival in the corporate performance. Reform agenda of the Government and its commitment to spend higher amount on infrastructure development is keeping the market sentiment positive despite ordinary corporate earnings data so far. It has been observed that, retail investors are getting back to equity markets and are excited about investing in midcap stocks which are in vogue at the moment. 

Let's check out what's happening in the midcap space...

Recently the CNX Midcap Index reached all-time high and Foreign Institutional Investors (FIIs) were seen buying aggressively in the midcap space. Global negatives which had put a pressure on Indian equity markets are slowly weakening now. Problems in the Eurozone have temporarily taken a back seat, possibility of Federal Reserve (Fed) in the U.S. raising rates has been factored into prices already and tensions between Iran and the western world have receded (after Iran successfully reached a nuclear deal). Lower oil and softer commodity prices are making India's macro story more compelling. Comfortable liquidity position in the global system is helping midcaps sustain premium valuations.

Overstretched Valuations
(Data as on July 29, 2015)
Source: NSE, PersonalFN Research

Picking quality midcaps at right valuations is more difficult than it looks. If you don't have expertise of picking the right ones or if you aren't taking any professional help; you may end up investing in a mislaying proposition.

So, before you get tempted by a midcap stock which is flying high, you need to come to terms with reality. While there might yet be many exciting midcap opportunities which look extremely attractive, you need to tread cautiously.

Macroeconomic scenario is not convincing yet. Companies are not very keen on capacity expansions. Many companies are not even utilizing their installed capacities at present. Industrial growth as measured by the Index of Industrial Production (IIP) is weak and prediction of below average monsoon is putting strain on already stretched valuations. Although foreigners as well as domestic investors have kept a lot of patience to see a meaningful recovery in corporate earnings, how long they would hold up, is something that remains to be seen.

What are the prospects?

Midcaps are exposed to a dual risk - broader sell off in the markets due to global or domestic negatives and earnings disappointment considering high expectations of investors reflected in the high valuations.

In such a scenario, if you don't have time and expertise to take decisions pertaining to your own investments but wish to benefit from the rally in midcaps, you may invest in a midcap oriented fund.

But before you take a binge, ideally ascertain your risk taking ability by taking into account the factors such as your age, income, expenses, asset & liabilities, time horizon and nearness to financial goals. While allocating your surplus in midcaps funds, please spread it over 3-4 funds which follow strong investment processes, rather than putting your money in one mid cap fund. This help you mitigate the risk.

Remember mid cap funds can help you 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 believes while there is no harm in investing in a midcap oriented mutual fund even now, you ought to follow a prudent selection approach. You should clearly avoid funds that follow market momentum, as this kind of an approach can be very dangerous for your portfolio. As midcaps are long term story, they are bound to be more volatile than large caps. Hence while you invest in midcap funds, opt for Systematic Investment Plans (SIPs) mode of investing as this would help you manage the risk better through rupee-cost averaging and power your portfolio with the benefit of compounding.

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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