The Hindu Business Line : Fund Talk

There has been a constant talk, in recent times, of the large-cap stocks being fairly valued as compared to mid-cap stocks. An investor who has made money in the past two years through diversified equity funds is caught in a dilemma whether to switch to mid-cap funds. At a time when most analysts are predicting a market downside, will large-caps or mid-caps fall more? Should I redeem 50 per cent of my diversified equity funds and shift to mid-cap funds? I have funds such as Franklin India Opportunities Fund, Sundaram Select Midcap and Reliance Equity Opportunities in mind for investing through the SIP route.

Iva Choudhary

The narrow rally of the past six months has placed large-cap stocks at a significant premium to mid-cap stocks. As a result, several stocks in the mid and small-cap space are attractively valued compared to large-caps. Therefore, we do think investors could benefit, at this juncture, by enhancing their allocations to mid-cap stocks.

However, you should note that low valuations will not necessarily protect mid-cap stocks from downside risk, in the event of a market correction.

Price trends in mid-cap stocks tend to be influenced more by the level of liquidity in the market than is the case with large-caps. Thin liquidity can magnify declines in mid-cap stocks during a sell-off, even if they are trading at bargain basement prices. Therefore, if you are considering a higher allocation to mid-cap stocks, you should be prepared for more volatility and possibly higher downside risk in the short term. But the attractive valuations in the mid-cap space do suggest that, if held through volatile phases, mid-cap stocks could deliver reasonably healthy returns over a longer holding period of say, 3 - 5 years.

If you are keen to enhance your allocations to mid-cap stocks through the mutual fund route, we would suggest you go about it in the following way:

Most diversified equity funds already invest in a mix of mid-cap and large-cap stocks. Check if the diversified equity funds you own do so. If they do, holding on to these funds may still deliver the benefits of mid-cap investing, as the fund manager may take the call to allocate a larger proportion of the portfolio to mid-cap stocks. HDFC Equity, Magnum Multiplier Plus and Franklin Flexicap are some of the good diversified funds with the flexibility to invest in mid-cap stocks.

If the funds in your portfolio have a large-cap orientation, consider adding funds such as Magnum Global and Sundaram Select Midcap to step up your allocation to mid-cap stocks. These funds have a long track record of performance. Since mid-cap stocks and funds could expose your investments returns to higher volatility, a 20-30 per cent allocation to such funds may be reasonable if you would like to contain downside risk.

The funds you have mentioned have all been top performing funds in 2006. We would not advocate selecting candidates for your portfolio based on a single year's performance. Top-ranking funds in a particular year could have delivered impressive returns merely because a specific theme or investment style was in vogue that year. In 2006, aggressively managed funds with focused sector exposures generally delivered a strong performance; such funds could expose the investor to relatively high downside risk.

Queries may be sent to: mf@thehindu.co.in or by post to Q&A, Business Line, 859/860, Kasturi Buildings, Anna Salai, Chennai - 600 002.

Aarati Krishnan

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