When most investors begin their hunt for a new equity investment, it starts and ends with a large-cap because of the familiarity attached to the name. There are many reasons to invest in large caps, but it is equally a good idea to expand one’s portfolio with a dash of mid and small caps. As a group, mid and small cap companies are smaller in size compared to their large cap counterparts, and under right market circumstances, these companies have a greater growth potential.
When it comes to large caps, it is all about resilience, irrespective of the way the economy moves. On the other hand, mid and small caps are an exciting segment of the stock markets which indicates the way the economy is moving. Drawing up from the game of cricket; if large cap is like the 5-day test match; mid and small cap investing is like the ODI (one day international) and T20 format which add excitement and calls for a different approach to playing the same game.
It is a fact that mid and small caps have the potential to grow at a faster pace than large caps during boom times but may equally lose out more than large caps during a bust phase of the market. As a result, they should be a part of one’s core portfolio allocation. Corrections could be steeper in the mid and small cap mutual funds, but the ability to yield returns higher than large caps in the longer time frame makes these funds attractive to the mutual funds equity investor.
Similarly, intelligent investors follow a similar tactic to spot opportunities in the market with which they could boost returns on their portfolio. Take for instance the performance of the mid cap and small cap indices in recent times. The Nifty Small cap 250 index is -3.76% YTD and Nifty Midcap 150 is 6.82% YTD. For a lay observer, this may appear to be under performance and many would even consider keeping away from the fear of further drop. Savvy investors will use this correction as an opportunity to enter mid and small cap mutual funds, which will spot fundamentally strong companies and invest into them at these attractive prices available. Don’t mistake this approach to a mindless purchase based purely on price drop; it involves knowing what is valuable and has the prospects of growing in the future.
The key point to note here is that mid and small cap investing is about betting on the future prospects of the company. Apart from this, exposure to mid and small caps also mean diversification within the equity universe and sectoral exposure. After all, not all the industries are represented by large cap names. Since different sectors perform differently during various phases of the economic cycle, sectoral diversification aids in creating a balanced portfolio. Also, within the same sector, there is a divergence between how mid and small caps perform as compared to a large cap.
This year so far, the Nifty 50 has yielded about 7.7 per cent, which is better compared to the performance of Nifty Small cap 250 index and Nifty Midcap 150. If you can live with volatility, you can start accumulating mid and small cap mutual funds whenever there is a drop in this segment. If you are already invested, you may continue to add more money into the same funds in order to average costs along the way. The upside of this approach is that in bull market phases, the performance of mid and small cap mutual funds will be much steeper compared to the large cap mutual funds, giving a boost to one’s overall investment portfolio.
Historically, small and midcaps have significantly outperformed in a rising market, and despite the extreme volatility in this segment, discerning investors invest in them to give the necessary boost to their portfolios in the long run. Spotting gems (winners) is an art and the mid and small cap segment offers a plethora of options to the fund managers, in terms of potential returns. You also need to factor how much you will allocate to this segment in your overall equity portfolio allocation. By using a balanced allocation to this segment of the market, you could build wealth in the long run.