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What are Mid-cap funds

The popularity of mutual funds continues to grow unabated among investors. According to a report by the Securities & Exchange Board of India (SEBI), investors spent Rs 171,000 crore on mutual funds in the year 2017-18. Mutual fund companies are targeting various segments of the market with different products to meet varying investment needs. The choices are wide-ranging and sometimes baffling for investors. They have to choose between large-cap funds, mid-cap funds, small-cap funds, infrastructure funds, debt funds, balanced funds and so on. Mid-cap funds have attracted investor attention in recent times because of their potential to offer very good returns for those who are willing to take a little bit of risk and volatility in their stride.

What is a mid-cap fund?

Mid-cap funds, as the name suggests, invest in mid-cap companies. So what exactly are mid-cap companies? The `cap’ here refers to market capitalization, a tool to estimate a company’s size. It is arrived at by multiplying the number of shares outstanding by the company’s share price. So if a company has 5 lakh shares outstanding and the market price of its stock is Rs 500, its market cap will be Rs 25 crore. Companies are classified as large-cap, mid-cap, and small-cap according to their market capitalization.

According to SEBI, the market regulator, a large-cap company is one that is among the largest 100 companies in terms of market cap. Mid-cap companies occupy the 101 to 250 rung, and small-cap companies account for the rest.

Mid-cap funds may also invest part of their funds in large-cap companies. SEBI has stipulated that such funds should have an exposure of at least 65 percent in mid-cap companies.

The mid-cap attraction

Large-cap companies are well-established and often dominate the sector they’re in. They have good corporate governance structures and made steady returns for investors over the years. A lot of research has been done on them and that information is readily available to investors. They are often considered a good bet by conservative investors. Mid-cap companies, on the other hand, are not often market leaders and riskier than large-cap companies, but they have the potential to offer higher returns in the longer term. Small-cap firms are relatively new to their field and are even riskier than mid-cap firms.

Any investor should have a mix of mid-cap and large-cap funds in his portfolio. The proportion, of course, will depend on various factors like age and risk appetite.

Things to consider while investing in a mid-cap fund

  • Age: This is an important factor to consider whether you should invest in a mid-cap fund or not. Since mid-cap companies are in the growth stage, they have the potential to offer fantastic returns, But you may have to wait a few years till your investment bears fruit. Mid-cap funds are ideal for mid-career investors rather than those close to retirement.

  • Risk appetite: Another factor is, of course, your risk appetite. Mid-cap funds tend to be volatile, and you shouldn’t allow large movements in NAV faze you. You have to understand that in a bear phase, shares of mid-cap companies can fall considerably. On the other hand, mid-cap companies tend to outperform during a bull phase. This is because they seek to capitalize on the opportunity to expand during good times, and also get credit and funds to grow.

  • Selecting the right fund: You may know what is a mid-cap fund, but there are dozens of companies offering mid-cap funds so you have to be careful while choosing the right one. Many well-established asset management companies offer these funds, so you can find one you can trust. Many websites have ratings of mutual fund offerings. By comparing ratings done by different sites, you can find a good one. Check for the returns offered over several years, and how the funds have performed during bullish periods (when mid-cap funds do especially well) and during bear phases (when they tend to go into a slump).

  • Expense ratio: Another factor you should be looking at is the expense ratio. This is the amount that the mutual fund charges you for managing your funds. There are significant differences in the amounts charged by different funds. Larger the expense ratio, lower your returns. So make sure that your fund charges a reasonable amount. Equity funds in India are allowed to charge 2.5% as expense ratio; some may charge as low as 1.5%.

  • Fund manager: The problem with many mid-cap companies is that they are under-researched and their potential is relatively unknown. This is where a good fund manager makes all the difference. He or she can separate the dross from the silver and ensure that you make great returns. Mutual fund companies offer a lot of information on their fund managers. Check out his or her track record and qualification before investing. Also, try to understand the investment philosophy behind the decisions. Avoid fund managers who constantly change their philosophy and follow trends. And as Warren Buffett said: “Never invest in a business you cannot understand”.

Realize the potential

Now that you have an understanding of what is a mid-cap fund, you must know that they can be an excellent investment if you are willing to wait out the troughs and sit tight for a minimum period of five years. There is a temptation among many investors to panic during a bear run and sell off funds; invest in mid-caps only if you are able to withstand the temptation. One thing you should remember about mid-cap companies is that in a growing economy, they have the potential to be giants. Businesses are evolving and companies are entering new fields of activity that hold enormous potential. A few decades ago, not many people had even heard of information technology. Today some of the largest companies in India are IT companies.

Large-cap companies too started off by being small-cap once. Today’s mid-caps could be tomorrow’s large-caps.

Having said that, a prudent investor would not put all his eggs in one basket. There should be room for a diversified basket of funds in your portfolio and include large-caps, mid-caps and small-caps as well. But if you’re a risk taker, go ahead and put them all in mid-caps, and small-caps.

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