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For the past couple of weeks, WiseInvest's chief executive officer (CEO), Hemant Rustagi, has been getting calls from clients to increase their allocation to mid-cap funds. "Generally, unless the investor is very experienced, we advise multi-cap funds to them because the fund manager will do the necessary churn without any tax implication," he says.
Rustagi isn't alone in getting such calls. A number of fund and wealth managers are seeing action from wealthy individuals and retail investors, suddenly coming back to the equities market and as some say, "Trying to make up for the lost time". And, mid-cap and small-cap stocks and funds are a bigger draw because they can turn multi-baggers faster than large-caps.
In the past three months, these segments have done exceptionally well. The BSE mid-cap and small-cap indices are up 30 per cent and 40 per cent, respectively. In comparison, the Sensex and Nifty have risen only 15 per cent and 16 per cent respectively.
Yet, many such as Rustagi are cautious in their advice. So, instead of investing in a mid-and-small cap fund, they are asking retail investors to put money in multi-cap schemes. "Only smart and experienced investors should put money in mid-cap and small-cap funds," adds Rustagi.
Reason for caution
There are a number of reasons for this. If a retail investor buys a pure mid-cap fund and there is a sharp decline in the short term (less than a year), as these stocks and funds are very volatile, he will have to sell the units and move to a large-cap fund. This will lead to a 15 per cent short-term capital gains tax.
In a multi-cap fund, he is saved the trouble of taxation for churning the portfolio because the fund manager can do so without any tax incidence. So, Dhirendra Kumar, CEO, of Value Research, believes investors should only invest in multi-cap funds, not even large-caps, for five to 10 years, without bothering about good or bad times. Others, however, suggest a mix of large and mid-and-small-cap.
Typically in good times, investors forget about the pitfalls of taxation or risk, especially when it is a one-way street of new highs. But while there is strong interest for these schemes or stocks, even in the best of times it isn't easy to choose a mid-cap or small-cap fund. Why? The answer is that the performance of these funds is so divergent that taking a call on the right one is difficult.
For instance, in the past year, Birla SunLife Pure Value Fund, which managed only Rs 45 crore in assets, has returned 79 per cent. Reliance Small-cap fund, which has Rs 361 crore, has returned 71 per cent. On the other hand, SBI Emerging Businesses Fund has returned only 16 per cent. The scheme manages Rs 1,268 crore in assets. Several other schemes have returns less than 30 per cent in the same period. On the other hand, the category average returns of multi-cap funds are 30 per cent. And, a larger number of schemes have returned over 25 per cent.
Hence, A Balasubramanian, CEO Birla SunLife AMC, favours a diversified fund portfolio. "Investors should divide their portfolio 50-50 between large-cap and mid-and small-cap funds and invest accordingly," he says.
Another important limitation Rustagi points to is if a mid-or small-cap scheme becomes too large, in terms of the assets, it loses flexibility because there are fewer stocks available for the fund manager to bet on aggressively. "One of the main problems of a pure mid-or-small-cap fund is that there will a mix of stocks that will do rather well and ones which won't. Given the limited number of great stocks in these segments, a very large fund would find it difficult to deploy funds," he says. Rustagi says investors should divide their equity fund portfolio by investing 60 per cent in large-cap and 40 per cent in multi-cap funds.
However…
While most experts believe retail investors who aren't very adept at handling market volatility should avoid stocks, Arun Kejriwal makes a strong case for these. "Whether it is a mid-cap fund or stock, one has to do research. So, they might as well pick a few good mid-or-small-cap stocks and hold these," he argues. According to BSE's definition, large-cap stocks are those comprising 80 per cent of the total market capitalisation, mid-cap stocks comprise 80-95 per cent and small-cap stocks 95-100 per cent.
A big problem with these stocks is they are under-researched. As a result, they can be priced wrongly. There can also be very high volatility in these, as they are the first ones to take a hit when sentiment changes. But the upside is that they can give far superior returns than large-cap ones.
However, Kejriwal says there should be some safeguards in the strategy. First, don't expect returns immediately. Second, don't buy stocks on hearsay or tip and without adequate research. Most important, learn to exit when you have reached your target. Retail investors, while buying such stocks, should set a target for the returns they intend to earn, along with the tenure. And, most important, exit when the target is reached. Also, the tenure of these investments should be lower than large-cap stocks or funds because many of these companies would be cyclical in nature.
Investment advisors say investors do their research or speak to experts and take a view on the stock's prospects. But once they have made their gains, they are not confident that they should let go of a good stock. So, they seek advice from someone else, who goes by the stock's historic performance and recommends they stick around. "As a result, they lose money or do not get adequate returns from their investments," he says, adding that market-savvy people can invest up to 40 per cent of their portfolio in these, whereas retail investors should not exceed 25 per cent.
Most investment advisors believe we are entering times when stocks are expected to outperform other investment vehicles. But retail investors would do well to remember the stock market is not a one-way ride and good investments need time to perform. While mid-caps and small-caps have become the flavour of the season, it would be wise to continue to keep a strong core portfolio of blue-chip stocks or good large-cap funds, to ensure the portfolio does not go through any shocks.
