Strike a balance between small and mid-caps

Focus on your goal, not just on what promises to grow fast

After an almost dizzying rise over the past few years, the first five months of 2018 have seen a fall in the valuation of mid and small-cap stocks, and the funds that have invested in them. In calendar year 2017, the large-cap BSE Sensex grew by 27.9 per cent and the BSE Midcap index by 48.1 per cent. In the period January 1-June 11, 2018, the BSE Sensex has grown by 4.2 per cent, whereas the BSE Midcap index has fallen by 10.2 per cent.

With the recent fall in mid and small-cap stocks, the inevitable fear about the entire sector is beginning to be felt. Also, there are questions about whether mid-cap stocks and funds are to be chosen at all. A look at why mid-cap stocks should always be a part of an investor’s portfolio.

Any business enterprise goes through a life-cycle comprising the following phases — it begins as a start-up, then goes through a period of high growth, matures into a slow-growth company and, finally, enters a period of decline.

There is nothing good or bad about mid-cap investing. It is just that when a company is younger or smaller, the chances of growth are higher than when it matures; so too are the risks. The company may not have the bandwidth to go past this stage.

 

 

 

In terms of their respective historical long-term performance, there is not much difference between the large-cap or mid-cap indices. In the period 2003-2007, mid-caps did better; between 2007 and 2013, large-caps did better. Again in the past four-odd years, mid-caps have done better.

When they rise, mid and small-caps are capable of rising much faster than the stocks in the large-cap category, but when they fall, they also fall much faster.

Why are we investing?

The idea is to have a clear articulation of why we are investing. With the help of a proper investment advisor, the investor can realise the different goals.

Each goal would have a separate combination of funds. The longer the time horizon for the goal (retirement planning), the larger should be the proportion of equity, and of mid-caps. Equities, in general, and mid-caps, in particular, should occupy a smaller proportion if one is planning to use the funds to buy a property within the next year or so.

Handling volatility

Let’s face it. Equity is not an asset class that gives steady, linear returns. Volatility is not necessarily bad, unless it leads to permanent losses. For an investor with a horizon of five years, it matters less if the fund’s NAV has fallen by 10 per cent, particularly if the fund has invested in companies with strong business models, and at valuations that are not significantly higher than long-term averages.

This is not the first time mid-caps have shown a downward correction. Nor will it be the last. Investors could have a proportion of the overall investments in mid-cap funds.

Gaining entry into companies that are in their earlier stages is not a bad idea. However, just as everything else in life, a balance is needed between more established companies and younger companies.

In choosing the proportion, one must focus on what makes sense and not just on what is promising to grow fast. Let us have at least three or four baskets to place our eggs.

The writer is CIO, DHFL Pramerica AMC

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