Best Midcap Funds For 2018. Look Before You Leap!

Dec 14, 2017

Mr Equity Market has been on the top of the world in 2017. Equity mutual funds made sure they did not miss out on the market rally over the past one year.

Smallcap Funds are up by a massive 40%!

Midcap Funds trail closely behind with a return of around 30%-35%.

Multicap Funds generated returns in excess of 25%.

Stable Largecap Funds too, did not miss out on the party and delivered returns in excess of 20%.

Exactly a year ago, on December 8, 2016 PersonalFN published this article: This Can Be A Good Time To Invest In Midcap Funds. Due to demonetisation that took the world by surprise a month earlier, investors were highly pessimistic on the impact on businesses and turned bearish. Share prices fell and valuations turned to look attractive.

Given the correction, PersonalFN wrote, "such dips in the market may be a good time to invest a small portion of idle cash for the long term (i.e. five years +)." Those who had invested in midcap funds a year ago, would now be sitting on returns in excess of 30%.

Let us have a look at the top performing midcap funds in 2017. This list includes smallcap and midcap funds as well.

Top 20 Midcap Funds in 2017: 1-year Performance*

*Please note, this table only represents the best performing midcap funds based solely on past returns and is NOT a recommendation. Mutual Fund investments are subject to market risks. Read all scheme related documents carefully. Past performance is not an indicator for future returns. The percentage returns shown are only for indicative purposes.

SBI Small & Midcap Fund led the list over the past one year, boasting of returns crossing 60%. L&T Emerging Businesses and IDFC Sterling Equity trailed behind with returns of over 50%. Had you invested Rs 1 lakh in these schemes, you would be sitting on a gain in excess of Rs 50,000. An investment in a fixed income product would have generated an income of merely Rs 6,000-8,000 pre-tax. All of the top 20 midcap funds delivered a return in excess of 30%.

The returns over the past one year have boosted the long-term 3-year returns of several midcap schemes. Have a look at the 3-year performance table below:

Best Midcap Funds: 3-year Performance*

*Please note, this table only represents the best performing midcap funds based solely on past returns and is NOT a recommendation. Mutual Fund investments are subject to market risks. Read all scheme related documents carefully. Past performance is not an indicator for future returns. The percentage returns shown are only for indicative purposes.

As can be seen in the table above, SBI Small & Midcap Fund and L&T Emerging Businesses Fund continue to lead the list in the 3-year periods as well. This is mainly because of their stellar returns over the past year. Going further down the list, the positions of the funds differ from their one-year ranking. There are a few new names too, in the top 20 midcap fund list, based on the past three year returns. You need to check for consistency in performance before selecting a midcap scheme.

Nonetheless, the returns over the past one-year have certainly been jaw dropping. Midcap funds and even Smallcap funds have certainly been the best performing mutual fund categories in 2017.

Will history repeat in 2018?

While the bulls are hoping so, the bears are waiting on the sidelines waiting to crash the party.

But, that is the nature of Midcap and Smallcap stocks. Such stocks have the tendency to go from thrilling highs to dangerous lows. Funds that solely invest in mid and smallcap stocks will incur higher risk. Investors need to be wary of the high volatility.

Is now a good time to invest in midcap funds?

Valuations! Valuations! Valuations!

Valuations are of critical importance for any investment decision. When you look at investments, especially midcap funds, it is necessary to assess whether the potential return is sufficient, given the potential risks. As prices and valuations rise, potential returns decline. The risk tends to increase and stock markets tend to be highly sensitive to events.

The monetary policy of the Reserve Bank of India announced on December 6, 2017 is a recent example. Markets remained extremely volatile and cautious with a downward bias. Even though most investors were expecting the RBI to sustain rates, the market headed lower. Hence, the market may react to such events in ways we least expect.

In our article published a year ago, our basic premise for investing in midcap funds was because valuations had eased. Now a year later, valuations have soared to unsustainable levels.

Have a look at the chart below:

Soaring Index Valuations of the S&P BSE MidCap Index and S&P BSE Small Cap Index

The price-to-earnings (P/E) of the S&P BSE Midcap Index has soared to over 40 times! The P/E for the S&P BSE Small cap index is at nearly 90 times!

These are extreme valuations. While many are expecting an earnings recovery to ease the currently high valuations, if earnings do not turn for the better, Midcap and Smallcap share prices may balk under pressure.

Given this situation, should you risk your money in midcap funds? Well, yes! Provided you adopt the systematic route.

Investing in mid-cap funds at high market valuations may not seem to be an optimal investment strategy. However, there is a sound rationale and a method to investing in mid-cap funds, given the current market environment.

A market correction is never the end. As seen in the past, the stock market always finds a way to bounce back.

Has the market peaked?

We cannot say for sure. But given the extreme valuations, there is a strong probability of a correction. But, when this will occur is doubtful. Hence, to deal with such uncertainty, it is always best to stagger your investments and invest regularly via a Systematic Investment Plan (SIP). You will save yourself from the stress of deciding whether now is a good time to invest in mid-cap funds.

In addition, if or when the market does correct, you will get the prefect opportunity to buy more units and lower the average cost of your investment.

PersonalFN believes that investors must adopt a logical approach when dealing with market volatility. If you sit on the sidelines waiting for a correction, you may be left behind and will lose out on the wealth-creation potential of mid-cap funds.

Which are the best midcap funds for 2018?

As 2017 draws to a close, many investors are now on the lookout for the best midcap funds for 2018.

If one simply goes by past returns, the best midcap funds in 2017 may not necessarily be the best midcap funds in 2018.

A simple search for the best midcap funds for 2018 or the top midcap funds for 2018 will lead to a deluge of investment advisers and distributors speculating which ones are likely to be the best. However, remember to take their advice with a pinch of salt. And, dig deeper.

Most rating agencies rank schemes on their past performance. Unfortunately, single point-to-point returns can be deceptive. Not all mutual funds have the capability to perform consistently. You need to analyse the returns of midcap funds across multiple periods and market cycles. Shortlist funds that have consistently outraced the market and their peers.

Apart from their performance, you also need to take a closer look at the portfolio. Due to their stellar performance, investors have flocked to these midcap schemes resulting in oversized assets under management (AUM). Because of the strong inflow of investments, many midcap funds have diversified into largecap stocks to curtail risk and to avoid liquidity constraints. A significant change in asset allocation can influence the long-term performance of the fund.

While the returns are certainly attractive, if you are planning to invest at this time, tread cautiously.

5 Important factors you need to look at before picking a Midcap Fund:

1. Past Performance
   
   Do not rely on the recent performance of a midcap funds. If the fund has consistently performed well across all market conditions and time periods, you could shortlist the midcap fund for investment.
2. Risk-adjusted Returns
   
   There is no doubt that midcap funds are risky. However, some funds are capable of managing risk better than other schemes. Hence, you simply should not ignore schemes that generate superior risk adjusted returns.
3. Portfolio Construction
   
   You may want to avoid schemes where the exposure is skewed to the top holdings. This concentration adds risk to already risky midcap fund. You may also want to avoid funds that have a disproportionate exposure to largecap stocks. Consider midcap funds that maintain a balance.
4. Fund Manager Experience
   
   The experience of the fund manager plays a crucial role in the performance of midcap funds. It will be sensible to stay with a fund manager who has extensive experience and a dependable performance track-record.
5. Fund House Quality
   
   You can assess the quality of a fund house by exploring how their other equity schemes have performed. If most of the schemes have generated a benchmark-beating performance, it is a sign that the fund house has put in place sound investment and risk management strategies.

Watch this video on how to select winning mutual funds in a few simple steps:

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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.