Mid-cap MF funds keep the faith

INVESTING

For over a year now, it's been mid-cap mania on the markets. Those of you who trusted in mid-cap schemes in 2004-05, must have been pleasantly surprised to see the kind of returns that you got.

Large cap funds meanwhile, turned in more modest performances as foreign investors, discovered that there was more to India Inc. than Reliance Industries or Tata Motors and that a whole host of smaller firms - whether in the pharmaceuticals or auto ancillary sectors - were fundamentally sound, raring to go and definitely worth a punt. 

Staying put
Large cap funds			Mid cap funds
Scheme Name	Latest AUM (Rs crore)	1 year return (%)	Scheme Name	Latest AUM (Rs crore)	1 year return (%)
Birla Advantage Fund	447.64	23.27	SBI Magnum Global Fund 94	152.06	81.14
HDFC Equity Fund	1071.35	23.19	Reliance Growth	1135.44	56.89
HDFC Top 200	571.30	22.78	Sundaram Select Midcap	295.16	52.72
DSP ML Opportunities Fund	599.52	20.97	Franklin India Prima Fund	1498.32	52.50
HSBC Equity Fund	1462.14	20.76	HDFC Capital Builder Fund	840.96	46.85
Franklin India Bluechip	1585.25	14.28	SBI Magnum Sector Umbrella - Contra	267.67	39.63
BSE Sensex		12.72	CNX Midcap 200		59.81
Source : www.mutualfundsindia.com & IL&FS Investsmart

A back-of-the-envelope calculation shows that a pure mid-cap fund earned investors four times that of a pure large cap fund and that's a handsome return.

While mid-cap schemes have stunned markets with their absolute performances, most of them have not managed to beat the benchmark CNX Midcap 200. The market capitalisation of stocks in the CNX Midcap 200 ranges between Rs 120 crore and Rs 3,750 crore.

Allahabad Bank, with a market cap of Rs 3,712 crore, tops the list, Crompton Greaves commands a market cap of Rs 2,422 crore, while Amtek Auto has a market cap of Rs 1,675 crore. At the lower end are companies such as Blue Dart Express with a market cap of Rs 787 crore and Alok Industries at Rs 856 crore.

On the other hand, the better performing large cap diversified schemes have all outdone the Sensex, returning on an average about 38 per cent.

Will mid-cap stocks and schemes continue to bring in good returns for investors going ahead? Yes, say most fund managers. Though the markets may be turning somewhat volatile and the visibility may not too good, they point out that the economy is still in fine fettle and that should help mid-sized companies.

"Corporate earnings overall should be in the region of 15-20 per cent in the current year and mid-cap stocks should do even better," observes Tushar Pradhan, senior fund manager at HDFC AMC.

Explains Sandip Sabharwal, head, equities at SBI Mutual Fund, "When the economy does well, mid-sized companies tend to do better because the leverage effect is higher.

Anup Bhaskar, head of equities, Sundaram Mutual is of the view that mid-caps are not only a good proxy for domestic economic growth; they are also a good play on falling interest rates.

"Most mid-caps are dependent on the domestic market for revenues whereas the larger companies are looking to export an increasing part of their production," says Bhaskar. True. With interest rates having come off by almost 500 basis points in the last two years companies are able to leverage at significantly lower costs.

A glance at some of the sectors which have potential to grow in the current economic scenario such as textiles, power equipment manufacturers, auto- ancillaries and construction don't have too many large cap players.

Observes Sabharwal, "a good many companies in these emerging sectors are mid-cap players and going ahead some of them will ultimately become larger."

Also, as Pradhan points out, many mid-cap companies have come off a steep learning curve and access to technology has helped them scale up their operations. "With global firms looking to lower costs, Indian firms have a great opportunity," he notes.

As for valuations, there is increasing consensus that the definition of "expensive "has to be realigned. Even about two years ago, mid-cap stocks were trading at extremely low valuations - some were available at earnings price-earnings (P/E) multiples of 2 and 3.

There has, of course, been a huge correction and they now command multiples in high double digits. For instance, Apollo Hospitals trades at a trailing 12 month P/E of nearly 30 while Amtek Auto trades at 22 times.

Balrampur Chini commands a trailing P/E of 14 times while Himatsingka Seide trades at 17 times. The CNX Midcap 200, at 2881 is currently priced at a trailing multiple of 14 times and that makes it less expensive than the BSE Sensex which at 6481 is available at a trailing P/E of 15.

Sanjiv Duggal, CIO, HSBC AMC, which has recently launched a mid-cap scheme, feels that mid-cap valuations today are at a slight premium compared with their large cap counterparts. Others, however, point out that though outsized gains can no longer be the norm, returns from these stocks will be in line with earnings.

Says Sabharwal, "Many companies may seem expensive today on one year forward earnings. However, since the earnings momentum is strong, on a two-three year perspective, they are not really expensive. For example, Allahabad Bank now quotes at a one-year forward multiple of 4 times, while Bajaj Hindustan trades at a multiple of 7.7 times estimated FY06 earnings. Stocks which fund managers have been shopping for in recent times include Kesoram Industries, Infotech Enterprises and Dhampur Sugar.

Mid-cap stocks are generally perceived to be "high risk-high reward stocks" being smaller and therefore, more vulnerable to a downturn. Duggal believes that the earnings of these companies tend to be more volatile.

"We feel that mid-cap schemes should form a smaller part of the allocation to equities. While the markets look reasonably good over a longer term of three years or so, we are more positive on large cap stocks."

But Pradhan says that though the companies may be small, they are fundamentally sound. However, it is true that being illiquid, they may be volatile.

"If you define volatility as risk, then they are risky," he says. All said and done mid caps have made investors happy. As Bhaskar says, "one can't paint them all with the same brush but as an asset class they look good". Let's hope he's right.