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Small-and mid-cap funds are likely to deliver attractive returns, but one must tread with caution

IN THE last one year (June 29, 2014, to June 29, 2015) small-and mid capfunds have delivered returns close to 30 per cent, which is amongst the best-performing category of equity funds.

During an economic turnaround, strong and mid-cap funds typically tend to outperform large-cap companies considering they see faster recovery in earnings, better cash flow helps working capital, interest rates are also lower, which reduces their debt and interest burden along with a faster revenue pick-up.

Besides, once the economy starts recovering, there is large domestic participation in the market which focusses on small-and mid-cap companies leading to a higher capital flow into these stocks hence repricing these assets.

According to Aashish Somaiyaa, managing director and chief executive officer, Motilal Oswal AMC, liquidity chases fundamentals; hence, supply is allocated where there is more potential for growth.

Citing that in the last financial year (14 months to date) ` 90,000 crore has come into equity mutual funds, of which almost half i. e. ` 45,000 crore has been allocated to mid caps.

If we take a look at some of the best-performing funds within the category, they have returned 40-50 per cent. Motilal Oswal Most Focused Midcap 30 Fund, for instance, delivered 50 per cent in the last one year.

"The fund philosophy is to buy companies which are showing secular earnings growth of 18-20 per cent in the last five years and ROE of 16-18 per cent", says Somaiyaa. The fund holds companies that are not deeply cyclical or trading at cheap price-to-earnings ratio.

While the Franklin India Smaller Companies Fund has been the best performer over a three-year period returning 42 Small & mid cap funds have given 30% return

per cent (as on June 29, 2015).

Janakiraman R, vice-president and portfolio manager, Franklin Templeton Investments India, who manages the fund, typically picks stocks where businesses are profitable, not asset intensive, and are capable of delivering more cash than what they absorb.

Having said this, the magnitude of alpha seen from these funds last year is not sustainable.

The valuations are on the higher side and in spite of the tremendous opportunities that lie in the small-and mid-cap segment, extra caution needs to be exercised due to the higher risk they carry. When the tide turns, these stocks also tend to fall more like the period of September 2012, when markets hit their rock bottom, small-and mid-cap companies were at their historic lows owing to higher leverage and inadequate demand, which puts pressure on these companies.

Over the last 10 years, mid caps have outperformed large caps by one per cent. Over the next five years, this outperformance is likely to be 1-2 per cent, says Janakiraman. He expects earnings to gather momentum over the next two to three years with an expectation of 15-per cent growth. Hence, investors who can stomach market volatility and have an investment horizon of more than five years could consider investing in madcap and small-cap funds.

Over the last 10 years, mid caps have outperformed large caps by 1%

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Publication:Mail Today (New Delhi, India)
Date:Jul 27, 2015
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