A portfolio-booster, but tread with care

With the Bombay Stock Exchange’s benchmark index, or Sensex, remaining flat for the last six months, many stock market investors, even first-time investors, are being advised that mid-cap and small-cap stocks could be a better bet. And with good reason.

While the Sensex and CNX Nifty have given returns of 1.55 per cent and 2.34 per cent, respectively, small- and mid-cap indices have risen 6.28 and 17.61 per cent, respectively. Over a one-year period, the numbers are quite stunning. The Sensex and Nifty rose 60.69 and 56 per cent, but mid- and small-cap indices delivered 104 and 129.50 per cent, respectively.

However, according to experts, while the experienced investor can look at such stocks or mutual fund schemes, first-timers should stay away. In fact, even an experienced investor should not go overboard. “Depending on your risk profile and investment goals, the allocation (to such funds) should be 10-30 per cent of your portfolio,” said Radhika Gupta, co-founder, Forefront Capital.

First-time investors who are yet to build a corpus can find themselves in trouble because these are high-beta stocks. In a falling market, mid-cap stocks or schemes will fall much faster and erode an investment’s value. Conversely, mid- and small-cap indices outperform the benchmark indices in a rising market. So, the mid-cap index could rise much sharper.

Therefore, investors need to exercise caution when looking to invest in this space. If you are not confident, take the mutual fund route. This is because most mid-cap schemes invest some part of the corpus in large-cap stocks, leading to some balance in the scheme. As per Value Research, schemes that invest less than 40 per cent of their assets in large-cap stocks are classified as mid-cap schemes.

Rajat Jain, chief investment officer (equities), Principal Mutual Fund, said: “In a rising market, if you buy one mid-cap multi-bagger, the returns could be much more than a mid-cap fund. But a fund has the potential to guard against any downside because of the presence of many other stocks that act as a hedge.”

Direct stock investors, though, need to hold these stocks for a longer period of time because it will help them to get better returns. Ajay Argal, co-head (equity), Birla Sun Life Mutual Fund, said: “A sufficiently long holding period, say three-five years, will help average out and book good gains.”

Before going for a scheme or stock, look at the performance for at least two years and, preferably, annual returns. A two-month return may be attractive, but there is no reason that the same trend will continue.

As for a mid-cap scheme, look at stocks and their respective market caps, say experts. The reason: A large number of mid-cap funds play safe by investing in large-caps — not a bad strategy if the market is going through troubled times.

But if the fund manager continues to play safe, even in a rising market, the scheme is not following its theme. Returns, as a result, will be capped. It’s better to go for a good diversified scheme in such circumstances. Also, if a mid-cap scheme has less than 20-25 stocks, it is betting too heavily on few stocks. It means too much of concentration and high risk.