Investors in stock markets in 2009 couldn’t have hoped for a better year. Even if they had invested in index funds, they would have earned a good 100 per cent return. And some equity diversified funds would have performed much better.
After a great run, things are expected to slow down this year. Market experts are already saying that ‘this would be a stock-picker’s year’ or ‘look for winners in mid-and small-caps’.
However, there is always a fear factor when investing in such stocks. For one, they are not as well-researched as large-cap stocks. So, it is a difficult proposition to identify the right ones.
Typically, mid- and small-cap indices tend to outperform the Sensex or the Nifty in a rising market. This is because many of them have quite a few high beta stocks. That is, if the Sensex rises by 1 per cent, the mid-cap index could rise by 1.5-2 per cent. Similarly, a falling market results in a sharper decline in these indices.
There are two ways to invest in mid- and small-cap stocks or funds. Either invest directly in them, or take the mutual fund route. Value Research, a mutual fund rating agency, defines mid- and small-cap schemes as those which have more than 40 per cent exposure to mid- and small-cap stocks. Schemes that have more than 40 per cent exposure in large-cap stocks are classified as large-cap funds.
Caution, though, needs to be exercised while investing in a mid-cap fund. A Balasubramanian, chief executive officer, Birla Sun Life Mutual Fund, said, “In case of a mid-cap fund, one should look at stocks the fund manager has been investing in and their respective market caps.”
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This is because a large number of mid-cap funds prefer to play safe by investing in stocks with large market caps. And, their exposure to stocks, which have a low market cap and could be potential winners, is much less. So much so that such funds’ top five holdings could actually be large cap stocks.
And then there are funds, which are actually risk-takers. They select potential winners and bet on them. As a result, in good times, they are big winners, and in bad times, big losers.
Given your risk profile, you could opt for a mid-cap fund with excess exposure to large caps or go for a scheme with a higher risk-taking ability. The scheme should be suitably diversified, both in terms of sectors and stocks. A well-diversified scheme reduces risks. “Any mid-cap scheme with less than 20 stocks is betting on few sectors and, hence, is riskier in nature,” added Balasubramanian.
Also, look at historical performance of the scheme for three-five years. Importantly, look at yearly returns as well. This will give you an idea of how the scheme has performed in different cycles. And compare it with peer schemes. For instance, a fund, which was launched in say 2005, would have seen the upmove in 2005-07, followed by a downtrend in 2008, and the partial recovery in 2009. Its performance over this time period should give a fair idea about the fund manager’s ability to take right decisions.
Besides these two parameters, look at a fund with low corpus because it makes the scheme more nimble. So it can enter and exit stocks at short notice. Investing in mid-cap stocks is a lot more difficult. But, for those willing to take the plunge, start by looking at borrowings of the company. “If the company has raised money from the stock market too many times, it can be avoided,” said Gul Teckchandani, an investment consultant.
The company’s business model is also important. “If a mid-cap company has large-cap peers, they might find it difficult to outperform. But if they are in businesses with little or no competition, they are more likely to be multi-baggers,” said Hitesh Agarwal, head - research, Angel Broking.
Hitesh gives the example of NIIT Technologies, which despite being an IT services provider, operates in a niche market, providing IT solutions for banking, finance services and insurance, transportation, and retail and distribution.
For investors with not much experience, it is easy to get lured by impressive returns. But keep only 10-20 per cent of your portfolio in such schemes or stocks. For first timers, start with large caps or index funds.
