Mid-Cap Funds are good for the long term

Mid cap funds have delivered sterling returns over the past few years. Investors in any mid-cap fund would have multiplied their money between eight to fourteen times in the past five years. This kind of wealth generation is unprecedented and unheard of in most other countries and it signifies the wealth creation possibilities in the mid-cap companies in India over the next few years.

Every investor strives to invest in stocks with huge growth potential, which are still unrecognized by the markets. Deemed as the big wealth creators in the market, mid-cap stocks are fast becoming favorites of investors, both institutional ad retail alike. Many mid cap companies have potential to transform into large cap companies over time, thus creating unfold wealth for investors in the process. Mid cap mutual funds serve as an ideal vehicle for investors wanting to take exposure to such mid-cap stocks.

Mid-cap mutual funds are simply equity diversified schemes which seek to achieve long term growth of capital by investing in mid-cap stocks. While there is no standard definition of classifying a stock as mid-cap generally companies with a market capitalization of between Rs 1000 crores to Rs 5000 crores are termed as mid-cap companies. Mid cap funds typically invest 70% to 100% of their portfolio in mid-cap companies. Mid-cap companies typically tend to be entrepreneur driven companies that are in the second stage of growth after the incubation period.

The foremost benefit of investing in mid-cap companies is the extraordinary growth potential of such companies vis-à-vis large cap companies. In the life cycle stage of a company, mid-cap companies are in the phase of further development and market penetration. They are hungry for capital to fuel their large future growth and typically exhibit aggressive strategies to capture market share. Again being largely entrepreneur driven, they do not suffer from longer reporting lines and greater bureaucracy as in case of their larger counterparts thus making them nimble-footed and quick to respond to changing market conditions.

Another advantage of mid-cap companies is that at times they are ignored of untracked by investment analysts. Accordingly a large cap stock like ICICI Bank may be tracked by hundreds of investment analysts but at the same time, a mid-cap stock like Vijaya bank may be relatively underexposed. Thus, these stocks remain largely under researched, which creates opportunity to invest in a company that is yet to be identified by the market. As a result, mid-cap companies may be available at relatively attractive valuations and may give tremendous returns in the medium to long term.

For past few years India has been witnessing a strong growth in entrepreneurial companies due to factors such as skilled workforce, favorable government policies, foreign direct investment, opening up of markets due to trade liberalization etc. As a result many mid-size companies, manufacturing world class products and providing high end services, have been making their mark in the growing global economy.

Large-cap companies on the other hand have reached a stage of maturity where they have captured a good market share and do not need any more capital as their business are generating enough capital to sustain themselves . Their growth prospects are organic as they exhibit steady growth. The big upside in large companies has already been captured in their growing phase and they tend to give relatively mature returns to investors.

Mid-cap stocks tend to deliver exceptional returns over a long term period. As empirically observed, considering a three year returns, BSE Mid-cap index has delivered a compounded annualized growth rate (CAGR) of 44% on an average outperforming BSE Sensex with CAGR of 41%. Mid-cap stocks like Aban offshore has delivered a CAGR of 179% for a period of five years while Divis Lab has delivered CAGR of 124% during the same period. Generally, stocks of sunrise industries are mostly mid-cap stocks in early stages. Since the unlocking of value in a mid-cap company takes at least few years, investors in mid-cap companies and funds should have an investment horizon of at least three to five years.

In the short term, mid-cap stocks tend to under perform large-cap ones in terms of risk-reward ratio. Mid-caps are more volatile, especially in the short term, and can be quite risky if investors get their timing wrong if they have invested with a short perspective. During a bearish phase a few months ago while large-cap stocks fell only 26%, mid-cap stocks fell higher by 36% exposing the relatively higher risk of investing in mid-cap stocks or funds.

The growth of mid cap funds with respect to assts under management has been quite robust. The cumulative corpus of mid-cap funds stood at a little over Rs 19,800 cr as of December 2007, which represents an annualized growth rate of 61% since December 2004.

Mid-cap funds have performed quite well, beating their benchmarks, especially in two and three year time frames, Sundaram BNP Paribas Select Mid-cap, Birla Mid cap Fund, Reliance Growth Fund, ICICI Prudential Emerging STAR Fund SBI Magnum Emerging business have been consistent performers, Mid-cap funds have, on an average delivered a CAGR of 54% over the past three years, and around 65% in the past year.

Past performance is no indicator of future returns. Mid-cap funds offer higher returns over the long term, albeit at greater risk. Those who are already invested in these funds should hold. Those desiring to invest in them now should enter, but only with a long-term perspective.