Equity markets nearing a bottom? Can one start SIP in midcap funds?
1 Mutual Fund Analysis April 04, 2013 Equity markets nearing a bottom? Can one start SIP in midcap funds? Preferred picks from Mid & Small cap Category: Note: Trailing Returns up to 1 year are absolute and over 1 year are CAGR. NAV/index values are as on March 28, 2013. Key takeaways: We expect that the Sensex and Nifty may be close to bottoming out in next few months. It may be a good idea to take exposure to some of leading mid cap funds to participate in the upside as small and midcap stocks have been hammered quite badly in recent times. While the Sensex has fallen 4.4% and 8.7% from its recent peak of Jan 2013 and earlier peak of Nov 2010, the BSE Midcap index has fallen 14% and 28% respectively. Mid and small cap stocks are high beta stocks compared to large cap counterparts. They fall as well as rise more during market ups and downs to large caps. Mid & small cap stocks depreciate more when market corrects but appreciate more when the rally starts. Further, many of midcap companies are becoming attractive on the valuation front which can provide better opportunity to grow over the short term as well as long term. An easing interest rate scenario coupled with correction in gold prices could be favourable for re-allocation into equities. Given the above facts, high risk appetite investors who wish to participate in the upside may consider investing in the above mentioned mid cap mutual funds and hold for 15-24 months. As the markets may take time to bottom out, staggered investment options such as SIP mode is advisable to invest in such funds.Equity markets nearing a bottom? Can one start SIP in midcap funds? Retail Research
2 Mutual Fund Analysis contd… The following charts show the upside movements of the mid and small stocks Vs. Large caps during in the periods especially the equity markets started to move up after sizeable correction. Whenever the market gains momentum, the mid and small cap stocks were the front runners and rose faster than large cap counterparts and participated in the initial leg of the market rally. Movements of key indices over periods: Rebound in Aug 2008: S e ns e x ( LH S ) 150 23000 B S E M id- C a p ( R H S ) 16000 S e ns e x B S E S m a ll- C a p ( R H S ) 21000 140 B S E M id- C a p 14000 19000 B S E S m a ll- C a p 17000 12000 130 15000 10000 120 13000 8000 11000 110 6000 9000 4000 100 7000 5000 2000 90 Jan-06 Jun-06 Oct-06 Mar-07 Jul-07 Dec-07 Feb-09 Jul-09 Nov-09 Jan-11 May-11 Oct-11 Feb-12 Jul-12 Dec-12 Sep-08 Apr-05 Aug-05 Apr-08 Apr-10 Aug-10 Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Sep-06 Aug-06 Mid & Small caps advanced large caps once rally started: Gained momentum by Mid & Small caps in Dec 2011: 260 S e ns e x 135 S e ns e x B S E M id- C a p B S E M id- C a p 240 130 B S E S m a ll- C a p B S E S m a ll- C a p 220 125 200 120 180 115 160 140 110 120 105 100 100 Mar-09 May-09 Jun-09 Jul-09 Dec-11 Jan-12 Feb-12 Mar-12 May-12 Apr-09 Aug-09 Apr-12Equity markets nearing a bottom? Can one start SIP in midcap funds? Retail Research
3 Mutual Fund Analysis contd… Why in Mid & Small cap stocks? Mid and Small cap stocks are high beta stocks and respond faster than large caps to the market information. They have higher return potential compared to large caps. The following are some of the reasons why Small / Mid cap companies offer higher return potential; •Relatively less known by market participants / price discovery by market is not full. •Better growth prospects due to presence in a new segment/ area that is growing at a faster pace. •Ability to gain share due to new technology, better product / service etc. •Smaller base of revenues and profits; hence growth rates can be larger. •Floating stock may be limited; hence small demand for stocks results in more than proportional rise in prices. •Room for P/E multiples to expand if the company transitions from a small / mid cap to large cap, etc. As far as large cap companies are concerned, the growth is lower as comparison to the period when they were mid cap companies as they are there in the relatively early stages of their business life cycles and their base was smaller. Mid-cap stocks also offers investors opportunities to capitalize on merger and acquisition activity as some attractive businesses have the potential to be acquired by larger firms. Small and Mid-Cap companies offer higher return potential than large cap companies and also carry higher risk than large cap companies, particularly over the short and medium term. Why in Mid & Small cap Mutual Funds? Equity diversified – Mid cap schemes invest in selective small & medium sized companies which are having higher growth potential and attractive valuations in relation to earnings or book value or current and future dividends. Returns: Mid & Small cap mutual funds outperformed other Equity diversified categories such as Large cap and Multi cap categories in terms of returns over the long run. (see the slide no. 5). Risk: Mid and Small cap funds are less risky than Large cap and Multi cap schemes if invested over the long period. (see the slide no. 4).Equity markets nearing a bottom? Can one start SIP in midcap funds? Retail Research
4 Mutual Fund Analysis contd… Risk: Mid & Small Cap Funds are less risky to Large cap and Multi cap schemes. The above diagram reveals the truth that the Mid and Small cap mutual funds are less risky in comparison to large cap and multi cap mutual funds over the long run despite the fact that the former is perceived to be carrying higher risk. But, Mid and Small cap mutual funds are risky portfolios over the short term periods. The above diagram compares the Standard Deviation (calculated from daily returns of schemes) of equity diversified categories for various time frames. The reason is that though the mid cap and small cap stocks are volatile in nature, most of these are subject to circuit filters in the trading exchanges which restrict the mid and small cap stocks from falling more during downturns or rising more during upturns. A large-cap stock is not subject to such freezes/circuit filters which results in the large cap category having higher daily volatility than mid cap or small cap counterparts. But it does not mean that the large cap stocks are more volatile than mid and small cap stocks where the down move of large cap stocks is restricted after certain level by their strong fundamentals. Further, the probability of loss is lower in case of the large cap on any given day than the midcap counterparts.Equity markets nearing a bottom? Can one start SIP in midcap funds? Retail Research
5 Mutual Fund Analysis contd… Returns: Mid & Small Cap Funds outperformed Large cap and Multi cap schemes over long run 25 Large-cap Mid-cap Multi-cap Sensex 20 15 10 5 0 1 Yr SIP 2 Yr SIP 3 Yr SIP 4 Yr SIP 5 Yr SIP 6 Yr SIP 7 Yr SIP 8 Yr SIP 9 Yr SIP 10 Yr SIP 11 Yr SIP 12 Yr SIP 13 Yr SIP The above diagram shows the performance of the SIP investments in equity diversified categories in various time frames. Apparently, the SIP investments which were made in Mid and Small cap funds showed higher returns than that of the investments that were made in large cap and small cap schemes. Further, the Mid and Small cap funds outperformed the Sensex in almost all the periods with considerable margin. Investments through staggered modes such as SIP is highly advisable in mid and small cap schemes given in their high risk profile nature. A small exposure to SIP in midcap scheme can be taken by all investors. However, It is worth noting that the investors have to be careful on choosing funds for the investments. Periodical review of portfolio (at least once in a year) can help to reshuffle out of persistent laggards.Equity markets nearing a bottom? Can one start SIP in midcap funds? Retail Research
6 Mutual Fund Analysis . Analyst: Dhuraivel Gunasekaran. (Database sources: AMC Sites, NAVIndia and Ace MF) HDFC Securities Limited, I Think Techno Campus, Bulding –B, ”Alpha”, Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Phone (022) 30753400 Fax: (022) 30753435 Disclaimer: Mutual Fund investments are subject to risk. Past performance is no guarantee for future performance. This document has been prepared by HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. This document is not to be reported or copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may have from time to time positions or options on, and buy and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or other services for, any company mentioned in this document. This report is intended for non Institutional Clients.Equity markets nearing a bottom? Can one start SIP in midcap funds? Retail Research