 "Navigating mid-cap minefield")
The temptation of the moment to buy mid-cap stocks could be irresistible. The BSE Mid-Cap Index enjoyed a stellar run in calendar year 2014, returning 55 per cent, almost twice the benchmark BSE Sensex. Analysts are expecting a sustained bull run and the mid-cap party is likely to continue. Yet, it's important that you don't get carried away by the frenzy, and put in place a sound strategy to plan your mid-cap adventure.
"There is a lot of froth in the space and valuations do not offer much comfort. Investors should be wary of putting money into these stocks," said Sandip Sabharwal, an investment adviser and former fund manager. According to him, a lot of poor quality mid-cap stocks rose with the quality ones in 2014 and the surge was driven more by hope than performance.
The BSE Mid-Cap index was trading at around 24 times its one-year trailing price to earnings ratio as of December 31, its highest year-end valuation in 10 years. It might be worth waiting a few months before shopping for quality names. "The second half of the year could offer better opportunities, as there is likely to be significant correction in the coming months," said Sabharwal. An impending interest rate cut a few months down the line is also likely to boost market sentiment in the second half.
Some experts, however, believe looking solely at mid-cap indices can be misleading. "Some mid-cap stocks lost 60-70 per cent last year, while others gave returns of over 500 per cent. One has to adopt a stock-specific approach and focus on good individual mid-cap ideas, rather than worry about index levels," said G Chokkalingam, founder, Equinomics Research & Advisory.
Avoid the common pitfalls such as putting money based on 'hot' tips or media reports or buying momentum stocks. Don't be in a hurry to exit good stocks and don't hold on to duds in the hope of breaking even. "Do not invest directly unless you have quality research to fall back on. Most investors will be better off taking the mutual fund route to invest in mid-caps," said Sabharwal.
Funds are choosy about picks and better equipped to assess a company's management capabilities, balance sheet, credit profile and so on. "The business environment is dynamic and stocks can move wildly in a day or two, giving investors little time to plan their exit. A fund is better equipped to manage these changes," said D D Sharma, chief executive, Risk Capital Advisory Services.
The sheer abundance of mid-cap stocks can be unnerving for direct investors as well. The market capitalisation of the BSE Mid-Cap index was between Rs 1,518 crore and Rs 19,101 crore as of January 7. That's roughly 3,000 stocks to choose from.
Sharma believes direct investors should not invest more than 20-25 per cent of their equity money in mid-cap stocks, unless they can digest high volatility. However, those taking the mutual fund route can allocate up to half their equity corpus in mid-cap funds.
So, note…
Direct or indirect, an investment horizon of at least three years is desirable. That said, you might have to constantly monitor the picks and weed out the underperformers. According to Chokkalingam, even multibaggers go through a V-shaped journey, meaning the stock could correct significantly before surging exponentially. He says investors typically dump mid-cap stocks if these remain stagnant in a rising market or fall in a rising or stagnant one. "Many investors have a stop-loss, to cut losses. But a correction might be a good opportunity to buy and average out costs. As long as the company fundamentals remain strong, investors should sit tight and wait till the story plays out. Nine of 10 mid-cap investors don't do this," he said.
Briefly put, investing in mid-caps is a high-risk, high-return game. So, avoid taking concentrated bets and allocate your money proportionally. Let's say you have Rs 200 and want to buy 20 mid-cap stocks. Put Rs 10 in each of these 20 stocks, rather than, say, Rs 50 each in a couple. This way, even if most of the stocks underperform but two or three emerge multibaggers, you can still make good money.
Investors should also closely monitor the liquidity of the stocks they get into. "Investors often confuse mid-caps with small-caps and invest in stocks with hardly any liquidity. Stay away if less than 100,000 shares of the company are traded on the exchange daily. Low trading volumes will also increase the impact cost," said Sharma. Also, avoid leverage or margin funding. This can backfire in a falling market if margin calls are triggered, as brokers can sell your stocks to recover their money. Mid-caps are a potential minefield. Focus on quality picks and buy at right valuations. Don't put all your eggs in one basket. Invest through mutual funds, if you can. It's your hard-earned money; don't let it blow up by making rash decisions.
Taking the MF route
A few mid-cap funds gave more than 100 per cent return in the past year. However, this is too short a period to assess a fund's calibre. Look at three-year, five-year, even 10-year returns to judge performance. Analyse the risk taken by the scheme to generate returns. Look at statistical tools such as Sharpe ratio, beta and standard deviation for this purpose. "It is easy to get carried away by short-term performance in good times. A high-risk strategy can backfire in a downturn," said Pankaj Murarka, head, equity, Axis MF. One can invest 30 to 50 per cent of an equity corpus in mid-cap funds, depending on risk appetite, goals and investment horizon. So, a 30-year-old can allocate a higher proportion to these as compared to a 55-year-old. Those unsure about allocation can invest in multi-cap funds, that shift between large-cap and mid-cap stocks, depending on the market condition. Look at the fund manager's long-term record. Note that some funds tend to outperform in a rising market but fail miserably in a downturn. Also, analyse the liquidity of underlying stocks owned by the fund. And, ensure the fund sticks to its mandate and does not allocate a high proportion in large-caps. Mid-cap funds are typically more volatile than large-cap ones. So, stay invested for at least three years to ride out the volatility.
"There is a lot of froth in the space and valuations do not offer much comfort. Investors should be wary of putting money into these stocks," said Sandip Sabharwal, an investment adviser and former fund manager. According to him, a lot of poor quality mid-cap stocks rose with the quality ones in 2014 and the surge was driven more by hope than performance.
The BSE Mid-Cap index was trading at around 24 times its one-year trailing price to earnings ratio as of December 31, its highest year-end valuation in 10 years. It might be worth waiting a few months before shopping for quality names. "The second half of the year could offer better opportunities, as there is likely to be significant correction in the coming months," said Sabharwal. An impending interest rate cut a few months down the line is also likely to boost market sentiment in the second half.
Some experts, however, believe looking solely at mid-cap indices can be misleading. "Some mid-cap stocks lost 60-70 per cent last year, while others gave returns of over 500 per cent. One has to adopt a stock-specific approach and focus on good individual mid-cap ideas, rather than worry about index levels," said G Chokkalingam, founder, Equinomics Research & Advisory.
Avoid the common pitfalls such as putting money based on 'hot' tips or media reports or buying momentum stocks. Don't be in a hurry to exit good stocks and don't hold on to duds in the hope of breaking even. "Do not invest directly unless you have quality research to fall back on. Most investors will be better off taking the mutual fund route to invest in mid-caps," said Sabharwal.
Funds are choosy about picks and better equipped to assess a company's management capabilities, balance sheet, credit profile and so on. "The business environment is dynamic and stocks can move wildly in a day or two, giving investors little time to plan their exit. A fund is better equipped to manage these changes," said D D Sharma, chief executive, Risk Capital Advisory Services.
The sheer abundance of mid-cap stocks can be unnerving for direct investors as well. The market capitalisation of the BSE Mid-Cap index was between Rs 1,518 crore and Rs 19,101 crore as of January 7. That's roughly 3,000 stocks to choose from.
Sharma believes direct investors should not invest more than 20-25 per cent of their equity money in mid-cap stocks, unless they can digest high volatility. However, those taking the mutual fund route can allocate up to half their equity corpus in mid-cap funds.
So, note…
Direct or indirect, an investment horizon of at least three years is desirable. That said, you might have to constantly monitor the picks and weed out the underperformers. According to Chokkalingam, even multibaggers go through a V-shaped journey, meaning the stock could correct significantly before surging exponentially. He says investors typically dump mid-cap stocks if these remain stagnant in a rising market or fall in a rising or stagnant one. "Many investors have a stop-loss, to cut losses. But a correction might be a good opportunity to buy and average out costs. As long as the company fundamentals remain strong, investors should sit tight and wait till the story plays out. Nine of 10 mid-cap investors don't do this," he said.
Briefly put, investing in mid-caps is a high-risk, high-return game. So, avoid taking concentrated bets and allocate your money proportionally. Let's say you have Rs 200 and want to buy 20 mid-cap stocks. Put Rs 10 in each of these 20 stocks, rather than, say, Rs 50 each in a couple. This way, even if most of the stocks underperform but two or three emerge multibaggers, you can still make good money.
Investors should also closely monitor the liquidity of the stocks they get into. "Investors often confuse mid-caps with small-caps and invest in stocks with hardly any liquidity. Stay away if less than 100,000 shares of the company are traded on the exchange daily. Low trading volumes will also increase the impact cost," said Sharma. Also, avoid leverage or margin funding. This can backfire in a falling market if margin calls are triggered, as brokers can sell your stocks to recover their money. Mid-caps are a potential minefield. Focus on quality picks and buy at right valuations. Don't put all your eggs in one basket. Invest through mutual funds, if you can. It's your hard-earned money; don't let it blow up by making rash decisions.
Taking the MF route
A few mid-cap funds gave more than 100 per cent return in the past year. However, this is too short a period to assess a fund's calibre. Look at three-year, five-year, even 10-year returns to judge performance. Analyse the risk taken by the scheme to generate returns. Look at statistical tools such as Sharpe ratio, beta and standard deviation for this purpose. "It is easy to get carried away by short-term performance in good times. A high-risk strategy can backfire in a downturn," said Pankaj Murarka, head, equity, Axis MF. One can invest 30 to 50 per cent of an equity corpus in mid-cap funds, depending on risk appetite, goals and investment horizon. So, a 30-year-old can allocate a higher proportion to these as compared to a 55-year-old. Those unsure about allocation can invest in multi-cap funds, that shift between large-cap and mid-cap stocks, depending on the market condition. Look at the fund manager's long-term record. Note that some funds tend to outperform in a rising market but fail miserably in a downturn. Also, analyse the liquidity of underlying stocks owned by the fund. And, ensure the fund sticks to its mandate and does not allocate a high proportion in large-caps. Mid-cap funds are typically more volatile than large-cap ones. So, stay invested for at least three years to ride out the volatility.