Mutual funds: Mid, small cap vs diversified equity

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Mutual funds are in the spotlight now and investment is flowing into the mutual funds through Systematic Investment Plans (SIPs) and lump sum investment and the AMCs are coming out with newer schemes to attract investors in every other category.

As per latest AMFI India report, total assets managed by the Indian mutual fund industry have grown from Rs 12.65 trillion in June 2015 to Rs 14.9 trillion in June 2016, representing 18% growth in assets over June 2015. MF schemes are so many now that the investors can select the one which suits their need and risk-taking capacity. AMCs are now offering large cap funds, midcap and small cap funds, diversified funds, thematic funds, index funds, debt funds and hybrid fund to name a few. In the past one year, the midcap funds gave around 3.6% return while diversified funds gave return of around 1% and in 3 years midcap funds gave the highest return of 32% while diversified funds gave 21%.

Let us look at the mid, small cap and diversified funds separately. Mid & small cap funds focus on stocks with less market capitalisation while diversified funds allocate funds across market capitalisation i.e. small cap, midcap and large cap stocks. So now the question is which is the right fund for an investor?

When markets are undergoing a correction or profit booking, we see mid and small cap funds losing steam and coming under pressure while diversified funds are seen giving up less returns or are less affected as investments are spread across various market capitalisation, large cap stocks will move down less compared to small cap stocks. This is because of the low market float of smaller companies. We saw the same situation after the Union Budget of 2015 when the markets hit record high and started to witness profit booking. Small cap stock witnessed more profit booking than large cap stocks which caused the NAVs of mid and small cap funds to decline more than that of diversified funds. Mid and small cap funds react quickly to market movements and multi-cap funds react less.

Which fund to select depends on individual’s preference. Investors who are ready to take in the market volatility and do have a long-term investment horizon may allocate a good part of their investment to mid and small cap funds as many small cap funds could turn out to be multi-baggers in the long run. Also, the fact is that liquidity, which is driving stocks, is likely to sustain, considering that it is based on fundamentals, that is, hope that the economy will do well. After deciding on the time horizon of investment, an investor must also consider the P/E ratio of mutual funds before investing. According to latest available data, funds are trading at P/E valuations below or near their category average pointing towards the fact that most of them are not overvalued hinting at chance of more upside.

Keep in mind that mutual funds can do wonders in the long run which can amaze the investor. So every investor must seriously consider mutual funds for a less risky and comparatively higher return.

The writer is Associate Director, Geojit BNP Paribas. The views expressed in this article are his own