Small, midcap funds generated better returns than larger peers

Himadri BuchMoneycontrolSmall- and mid-cap equity funds are racking up significant gains over their large cap peers over both short and long-term time-frames.In fact, a closer look at the performance of equity MFs suggests that mid- and small-cap schemes have generated better returns compared to largecap focussed funds over three, five, and 10 years.Generally, large companies tend to perform better than mid- and small-sized companies during difficult times. However, the opposite has been true for the last 10 years. Going forward, too, fund and wealth managers remain optimistic about the prospects of mid- and small-cap stocks over the next three years.Over the last three years, small-cap funds delivered compounded annual returns of 39.62 percent against midcap schemes' 30.49 percent and largecaps' 15.18 percent. Across the last five years, large-cap funds delivered an average return of 12.53 percent, way below average returns of 24.92 percent clocked by small-cap funds and 20.72 percent given by mid-cap schemes.In comparison, Sensex and Nifty delivered 9.54 percent and 10.18 percent, respectively, over the same five-year period. During this time, S&P BSE Mid Cap gave 16.17 percent returns and S&P BSE Small Cap returned 13.99 percent. Over 10 years, mid- and small-cap funds outperformed large-cap funds by over 400 basis points.Why this spurt in mid and smallcaps?Fund managers say that mid- and small-cap funds are benefiting to a large extent on account of MFs cherry-picking beaten-down stocks. Sectors, which are under stress, like banking, real estate, capital goods and auto have outperformed since the Budget during the market recovery.Gopal Agrawal, Chief Strategist, and Senior Fund Manager at Mirae Asset Global Investments has a convenient rationale for the stellar show seen in these funds. He says some of the mid and small-cap companies have been able to deliver robust growth in sales and PAT numbers. "Because of a smaller base, the growth in PAT and EPS gets magnified."Some of the midcap stocks have rallied up to 70 percent so far in 2016 or have had witnessed a turnaround in the last 2 quarters. Stock market rewards these companies handsomely when such kind of growth happens. This kind of growth is obviously not visible in large cap stocks and they deliver muted returns, although the risk may be far lesser, Agrawal added. "The most important point is to identify a midcap company with a management that has a strategic vision and is driving the business for durability and sustainability," he said. However, picking the right ones is important because not all of them beat their own benchmarks. In the mid cap fund space, 22 out of the 81 funds lagged their respective benchmark indices over a 1-year period. Biggest outperformers include Mirae Asset Emerging BlueChip Fund, DSP BlackRock Small and Midcap Fund, Kotak Midcap Fund, HDFC Mid-cap Opportunities Fund. Baroda Pioneer Midcap, Axis Midcap Fund and Tata Midcap Growth Fund were the worst under performers.In the three-year time frame, the benchmark of most mid-cap schemes, Nifty Free Float Midcap 100 Index gave 27.15 percent returns. In comparison, among 65 schemes, 47 funds outperformed the benchmark. The biggest outperformers include Mirae Asset Emerging Bluechip, UTI Mid Cap Fund, Birla Sun Life Pure Value Fund, Sundaram Select Midcap Fund and JP Morgan India Mid and Small Cap.In the small cap fund space, out of 28 schemes, only 2 schemes failed to beat their respective benchmark returns during the three-year period. The biggest outperformers include DSP BlackRock Micro Cap Fund, Reliance Small Cap Fund and Canara Robeco Emerging Equities while the worst among laggards include HDFC Small and Mid Cap Fund, Edelweiss Emerging Leaders Fund and Escorts High Yield Equity Fund. Going forward, mutual fund experts are skeptical about the performance of these funds as most believe that momentum in mid and small cap stocks may not continue which could dent returns of the underlined schemes.“Because P/E is high, mid and small cap stocks have gained, but now earnings momentum has decelerated so the gains in the mid and small companies will not last long. Any external shocks will puncture these companies,” said Dhirendra Kumar, CEO of Value Research, said.He recommends investors to fully diversify their portfolio. He also says investors must give money in the hands of good fund managers.Currently, there are over 400 equity-oriented schemes in India, with assets of 4.68 lakh crore at the end of September. The assets under management have more than doubled in the past 20 months, primarily due to robust inflows in equity schemes.