Go slow with mid-caps

These get squeezed in an economic down cycle, so be selective when investing in funds

Despite the BSE mid-cap index falling nine per cent, against the BSE Sensex's 2.3 per cent gain, mutual fund houses are lining up more products that target the mid-cap space. Through the past few months, fund houses have been launching value funds that invest in the mid-cap space.

Should investors consider mid-cap funds?

Mid-cap stocks have not fared better than the Sensex. Through the past five years, the BSE Sensex logged 15.3 per cent annualised returns, while the BSE mid-cap index gained 13.6 per cent. And, gains in the BSE Sensex have been more stable and steady than those seen by mid-cap companies. Don't bet on this trend reversing anytime soon.

There has been a shift towards buying the stocks of companies that have been beaten very badly in recent times and so, the mid-cap space has seen some action in the recent past. Market watchers say mid-cap stocks fell sharply in the last two years, adding some of these stocks are looking attractive. Mehraboon Irani, head (private client group), Nirmal Bang, says, "As there aren't too many triggers for the overall market, the shift is now towards mid-caps and, therefore, it is possible mid-caps could do well. Some of these were beaten down very badly in the past two years."

In good times, mid-sized companies can grow faster than larger, more established entities. They can add scale, size and market share more quickly and, therefore, are in a position to clock faster growth. In 2009-10, when the economy was recovering from the crisis triggered by the collapse of Lehman Brothers in 2008, mid-caps outperformed larger companies. The BSE mid-cap index recorded 53 per cent annualised returns through the two years ended December 2010, compared with the BSE Sensex's 43.9 per cent returns.

Now, with the economy not out of the woods yet, experts say mid-caps should be added at a very slow pace. If your entire portfolio is in the large-cap space, you could shift a small portion to the mid-cap segment.

After keeping away from the segment earlier, wealth managers are now beginning to recommend mid-cap funds. Rajesh Iyer, head (investments and family office), Kotak Wealth Management, says: "Mid-cap funds have started to look a little better now, as the economy is showing signs of bottoming out. We are looking at the mid-cap once again; and investors can have exposure of about 15 per cent of equity in mid-cap funds."

But be cautious! Mid-cap companies can be more volatile than their larger counterparts and show more choppiness. As a result, investors may be taking greater risks by including mid-cap stocks. Irani says, "Both economic factors and momentum can drive mid-cap stocks. So, index movements of mid-caps are more sporadic than those of large-caps. Therefore, one should be more cautious here."