Avoid the roller coaster

Valuations are cheap, but there’s no reason why one can’t get them cheaper in these times.

There is one important thing that investors in mid- and small-cap mutual funds need to have: A strong heart. When the benchmark indices — Sensex and Nifty — fall, these schemes can crash. On the other hand, when markets are doing well, these schemes can easily do much better. No wonder, markets experts are always seeking the next multi-bagger in the mid- and small-cap space.

Stocks in the small and midcap segments are of a high beta, that is, they are highly volatile. High-beta stocks are supposed to be riskier but provide a potential for higher returns.

According to data on Value Research, in the last one year, the small-cap and mid-cap mutual fund category has dipped 19.5 per cent. The large-cap fund category, during this period, has fallen by 17.42 per cent and the index fund category has dropped by 18 per cent. And during the bull phase of 2007 the mid-cap and small-cap category rose 60.77 per cent and the index funds by 47.15 per cent and the large-cap category by 50.54 per cent.

Given these numbers, there is always the worry on whether one should have exposure to these schemes at all. Or, when is the right time to enter?

“With conditions in the Euro zone likely to worsen, markets will go down further,” says Suresh Sadagopan of Ladder7 Financial Advisors. “So, it isn’t the right time to invest in these for the short term, due to the volatility the markets will see." Those with a short-term time horizon (less than six months) should stay away,” he adds.

Jaideep Bhattacharya, Chief Marketing Officer at UTI Mutual Fund, says a larger exposure to large-cap fund will help in these times and only a small part of the portfolio in these schemes. "Mid-cap and small-cap funds will only reap benefits if you stay invested in them for the long term. That is more than five years," he notes. "For those interested in the short-term, we advise them to invest in debt funds such as fixed maturity plans or balanced funds."

Typically, a person with 80-20 equity debt portfolio can put 20 per cent of the 80 per cent equity exposure in these schemes. The aggressive investor can consider these funds and have a high exposure, up to 50 per cent. But these funds are a strict no for risk-averse investors.

Yes, the big carrot for investors at this point in time would be valuations. But there is no reason to believe that these funds cannot be bought at even cheaper valuations.
 

THE RIDE SO FAR                                                                             (Rise/fall in %)
Category/index	2006	2007	2008	2009	2010	YTD*
Large-cap	40.45	50.54	-50.66	73.27	17.84	-17.63
Mid- & Small-cap	28,34

60.77 -60.09 98.14 20.30 -15.94 S&P CNX Nifty39.8354.77-51.7975.7617.95-18.83 BSE Sensex46.7047.15-52.4581.0317.43-19.27 *YTD as on 10th October 2011                                                                                            Source: Value Research

UTI’s Bhattacharya says, for a first-time investor, it may not be advisable to look at such high-beta segments. “A rookie will be better off investing in a hybrid fund and diversified equity fund with a large portion of the fund allocated to large caps."

Vicky Mehta, senior research analyst at Morningstar. says that since these funds offer a high risk-high return investment proposition, investors need to be aware of the risk involved and have a long-term investment horizon explains. A small or mid-cap fund can be apt in a supporting role in your portfolio. The allocation should be linked to the investor's risk-taking ability.