Mid and small-cap stocks have had a torrid time over the last five years, failing to keep up with blue-chips in the rally and falling more sharply during corrective phases in the market. In fact, a comparison of returns on the CNX Midcap index with the Nifty shows that the mid-cap index has lagged on five-year annual returns, managing about 10.6 per cent to the Nifty's 11 per cent.

This consistent underperformance has widened the valuation gap between large and mid-cap stocks,providing an entry opportunity in to mid-caps for investors who are targeting high returns over the long term. The DSP BlackRock Small and Midcap Fund appears a good option.

Beating the index : DSPBR Small and Midcap Fund has been the rare mid-cap fund to easily beat the mid-cap benchmark over the past three years. Less than half the mid-cap funds in operation beat the CNX Midcap in this period. Only three funds matched DSPBR's record.

True mid-cap focus : The fund's stringent focus on mid- and small-cap companies, rather than emerging large-caps, makes for a higher return potential for its portfolio. About 71 per cent of the portfolio was invested in stocks below the Rs 7,500 crore market cap threshold .

Controlled risk : Even while staying ahead of the category average in a rising market, DSPBR Small and Midcap fund contained the downside in its NAV during the recent market fall to levels close to the Midcap Index.

The CNX Midcap Index has lost 21 per cent and the entire class of mid-cap funds lost 21.3 per cent. The DSPBR Small and Midcap Fund's NAV shed 20 per cent in this period.

The fund uses a mix of raised cash and derivative positions, a focus on low PE stocks and a very diversified portfolio to contain the risks associated with the wild swings in mid-cap stock prices. Having raised its cash position from about 6 per cent to 11 per cent between September and November 2010, just ahead of the recent market fall, the fund has since retained fairly high cash/debt at about 15 per cent of the assets.

The sector profile of the portfolio suggests a value-focussed bottom-up approach to stock selection that may pay off well in a challenging environment. The fund's top holdings were such under-researched names as Trent, EID Parry, Areva T&D and Indian Hotels leading the list. The fund's offbeat preferences may help contain portfolio swings during volatile market phases.

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