Valuations: Popular mid-cap funds struggle to keep pace with rising benchmarks

Mumbai: Mutual funds that bet on mid-cap stocks, one of the most popular product categories in recent times, have struggled to outperform their benchmarks over the last three years. Of the 25 funds that invest in mid-cap stocks, only five have managed to outperform the benchmarks. Nifty 150 Midcap IndexAnalysts and investment advisers say the inability to deploy continuous flows into these schemes and the increased exposure to blue-chip securities, with ratings The fact that midcaps remain elevated has led to underperformance.

Value research data shows that the actively managed midcap fund category has generated an average return of 25.36% compared to the Nifty 150 Midcap index’s return of 27.08% over three years.

“With high capital inflows into mid-cap stocks in recent years, market efficiency “For midcaps, the situation has improved a lot. This means there is less scope for active managers to find undervalued stocks and generate alpha,” says Kunal Valia, founder of Statlane, an investment advisory firm.

Mid-cap funds recorded net inflows of ₹24,440 crore in the last 12 months, compared to ₹34,386 crore in smallcap schemes and ₹7,287 crore in largecap schemes.

Mid-cap funds must hold at least 65% of their capital in stocks ranked between 101 and 250 by market capitalization. The remaining 35% is at the discretion of the fund manager.

Analysts said fund managers “Limitations in terms of ability to take exposure to some of the low-quality stocks in the midcap index, along with managing large inflows in bull markets, have led to the underperformance of midcap active funds,” says Vidya Bala, founding partner, Primeinvestor.in. The continuous flow of money into equity mutual fund schemes, including midcaps, has helped the market move from strength to strength despite growing concerns that valuations of smaller companies are overvalued.

The Nifty Midcap 150 index is trading at a price-to-earnings (PE) ratio of 44.2 times, compared to its five-year average PE of 28.32.

The index has gained 27% so far in 2024, 50.21% in the last one year and 105% in the last three years. The Nifty has gained 15.22%, 30.74% and 47.97% respectively during these three periods.

Active or passive mid-cap funds?
Valia said the higher expense ratio of actively managed mid-cap funds relative to index funds is also a reason for poor performance.

For some asset managers, actively managed funds remain better options in a bull market.

“Currently, we are in a market phase where there is a broad-based rally, but the euphoria in some segments of midcap and smallcap stocks and risk is being ignored,” says Ashish Shankar, CEO, Motilal Oswal Private Wealth. “I would still stick to active funds as they are better positioned to manage risk.”

Bala advises investors to maintain a mix of active and passive mid-cap funds in their portfolios. “This will ensure that they keep pace with the market at all times and generate significant alpha,” he said.