Mid- and small-cap funds steal the show

Fund managers believe the risk-reward equation will now favour large-caps

Equity mutual funds (MFs) have done very well in 2016-17 (FY17), outperforming their benchmarks. The median open-ended equity scheme provided 27 per cent return to its investors in the past 12 months, better than the 17.8 per cent appreciation in the benchmark S&P BSE Sensex during the period. 

MFs didn’t disappoint in the short term either, with a typical equity scheme giving 14.9 per cent returns in the past three months, against the 12.2 per cent return provided by the benchmark index during the period. Not surprisingly, individual investors continue to flock to MFs, with most successful schemes reporting strong inflows through systematic investment plans (SIPs). 

However, as in the equity markets, not all MF investors were equally lucky. The year belonged to the small- and mid-cap schemes, while large-cap and sector-focused funds lagged. “The schemes reflect the trend in the broader market where small- and mid-cap indices have done better than the benchmark indices consisting of large-caps,” says Navneet Munot, chief investment officer, SBI MF.

Funds focused on mid-, small- and micro-cap stocks stole the show, with the median small-cap fund gaining 34.1 per cent returns in the past 12 months and 23.9 per cent annualised (compounded annual growth rate) returns in the past five years. Mid-cap schemes were second best, with median returns of 32.8 per cent in the past 12 months and 23.3 per cent in the past five years. On the brighter side, all categories of funds provided higher returns, compared to the broader markets in general. 

Large-cap funds came after both categories with 20.5 per cent returns in the past 12 months and 14.5 per cent annualised returns in the past five years. Other categories, such as tax planning (equity-linked savings schemes), sector-focused and multi-cap funds were better than large-caps in terms of performance (see table). The analysis is based on 171 open-ended equity schemes with five-year performance record and assets under management of at least Rs200 crore as on March 28, 2017. The data was sourced from Value Research.   

Large-cap companies have stagnated over the past three years, with the combined net profit of Nifty 50 companies hovering around Rs 70,000 crore for three years now. As a result, large-cap funds did not perform well last year. “Investors flocked to mid- and small-caps not because they offer great growth stories but because of the inability of large-cap ones to show earnings growth in the past few years. However, if growth revives, large-cap stocks won’t be left behind,” says Anoop Bhaskar, head of equities at IDFC MF. 

Fund managers have now turned cautious on mid- and small-cap stocks. “In a bull run, mid- and small-caps always outperform benchmark indices but valuations have turned rich in the segment, while large-cap stocks are relatively cheaper,” adds Munot.

Bhaskar agrees. “Large-caps still account for 82 per cent of the market by value and investors risk missing a major wealth creation opportunity if they ignore large-caps for long.”

Methodology

The equity funds were selected through a three-stage filtering process. First, all open-ended schemes with assets under management (AUM) of Rs200 crore or less as on March 28, 2017, were excluded. Funds whose performance record was not available for the past five years were also left out. This led to a list of 171 equity schemes. In the first stage, all schemes were ranked according to their performance in the past one year, three years and five years. Thereafter, the best performing scheme rankings were calculated, giving highest weightage (50 per cent) each to their long-term performance (five-year) and 25 per cent weightage each to their three-year and one-year performance. In the second stage, funds were ranked based on their risk-reward ratio (key quality parameters) – Sharpe ratio (30 per cent weightage), Sortino Ratio (40 per cent ) and 15 per cent each to beta and alpha. Finally, 30 per cent weightage each was assigned to expense ratio and weighted average growth rank, and 40 per cent to their rank on risk-reward (quality parameters) ratio.

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