Mid and small caps are an intriguing space, given its high-return potential as well as riskiness. Little wonder that there is confusion in investors’ minds about it. Here are the answers to the most pressing questions that may have been bugging you.
The title and subtitle of this article pretty well sums up all there is as far as the introduction is concerned. So, let’s do it a little differently. Here is a list of top 10 wealth creators in BSE 500 (as of May 8, 2023).
| BSE 500: Top 10 wealth creators over the last 10 years | |||
| Company | 10Y return (% pa) | Current market cap (Rs cr) | Worth of Rs 1 lakh invested 10 years ago (Rs) |
| KEI Industries | 67.32 | 17,920 | 1,72,02,598 |
| Tanla Platforms | 66.88 | 9,118 | 1,67,51,852 |
| Navin Fluorine International | 60.75 | 23,737 | 1,15,18,884 |
| UNO Minda | 58.38 | 30,361 | 99,33,117 |
| Alkyl Amines Chemicals | 55.55 | 12,945 | 82,94,821 |
| SRF | 53.71 | 75,474 | 73,63,071 |
| Tata Elxsi | 52.70 | 42,061 | 68,94,787 |
| APL Apollo Tubes | 51.21 | 32,918 | 62,48,750 |
| Balaji Amines | 51.07 | 7,641 | 61,89,895 |
| Avanti Feeds | 49.27 | 5,084 | 54,91,638 |
| Data as on May 8, 2023 | |||
As you can see, the biggest wealth creators are all mid and small caps. Mind you, 10 years ago, these companies would have been even smaller. Some of them may have been micro caps. The prodigious wealth-creating potential of mid and small caps is what makes many investors interested in them. But investing in this segment is not free from risk. Rather, it would not be wrong to say that there are more risks than rewards. For every winner, there are multiple losers. Because losers get wiped off from the scene, what you see is winners alone. That’s called survivorship bias.
But let’s leave discussion on psychological biases for another day. For now let’s proceed with the first oft-asked question.
1. Should I invest in mid and small caps?
Yes and no. It depends on your risk-taking ability. Sure, you may get extra returns by investing in mid and small caps but you also have to digest extra volatility. So, the road to extra returns is bumpy and rocky. See the chart below. It shows the seven-year daily rolling returns of the BSE 150 MidCap and BSE 250 SmallCap indices vis-a-vis the Nifty 50 over the last 10 years.
While mid caps have clearly outperformed, small caps have found it difficult to outpace the Nifty 50? So, investing in small caps is not a sure-shot path to good returns. However, if we see the volatility of these returns, mid and small caps are surely more volatile.
So, should you invest in mid and small caps? While most stock and fund portfolios will have exposure to mid caps, add an extra flavour of mid and small caps only when you can digest the volatility involved. Also understand that there is no guarantee that mid and small caps will always outperform their larger counterparts.
2. How should I invest in mid and small caps?
Should you invest directly in mid and small caps or should you invest via a fund? As mentioned above, mid and small caps can be very volatile. The reason for their volatility is that their underlying businesses can go through sharp ups and downs with changing economic scenarios. That’s why during boom times, they do well; and during doom times, they crash. Thus, when you pick mid and small caps, you should be absolutely certain of their quality and business strength. If you can do stock research on your own and have the time to track the performance of companies, you can invest in mid and small caps directly.
However, most investors will have problems navigating this tricky space. So, the mutual fund route remains the better option for the majority. With mutual funds, you can get the services of an experienced fund manager who will pick winning mid and small caps on your behalf. If your chosen fund underperforms, you can also switch to a better one. Last but not least, when you invest in a mid- or small-cap fund, you get a diversified portfolio straightaway. All these help you lower your risk and optimise your returns.
3. What’s the right time to invest in mid and small caps?
Should you invest in mid and small caps when they are down? Or should you invest in them irrespective of the fact where they are headed?
Let’s take these scenarios over the last 10 years for the BSE 150 MidCap and BSE 250 SmallCap indices:
- You invest in the two indices when they have fallen by 2% or more with respect to the previous day’s close.
- You invest in the two indices on the first of every month, irrespective of the market levels.
The charts below show the (XIRR) returns you would make.
As you can see, investing on the dips can get you better returns. However, the difference isn’t much. Plus, there is the practical difficulty of investing when the markets have fallen. You will need to be on your toes with tracking the market movements. Another difficulty is that if you are investing in a fund, the units will be allotted only at the day-end NAV. So, you may or may not be able to capture the dip effectively. Hence, regular SIPs are the better option.
Here is a bonus video on small-cap investing that can be useful to you: Is it a Good Time to Invest in Small Cap Funds? When to Buy and Sell Small Caps? An ETMONEY Study.
If you are a stock investor, paying attention to just the market levels may not be enough. You will have to specifically analyse the fundamentals and the valuations of the stocks you are interested in.
4. How much allocation should I have in mid and small caps?
If you have made up your mind to add mid and small caps to your portfolio, the question that arises now is how much should you allocate to them? There is no right or wrong answer to it. It all depends on your risk appetite and how comfortable you are with the volatility in your portfolio.
If you would like to have a basic equity portfolio, you can avoid mid- and small-cap funds altogether and focus on just flexi-cap funds. Flexi-cap funds will have allocations to mid and small caps, as deemed fit by the fund manager.
However, if you would like to add a kicker to your portfolio returns, you can add mid- and small-cap funds to it. But avoid going more than 30-40% of your total portfolio. While a larger percentage of mid and small caps can boost your returns, they also make your portfolio more volatile. Hence, choose cautiously.
As far as stock investors are concerned, they would find many worthwhile options in the mid-cap space and hence can’t really ignore it. The idea is to be prudent with stock selection. As far as small caps are concerned, even stock investors can do without them if they don’t want extra volatility in their portfolios.
If you do invest in small-cap stocks, understand that you must research them even more profoundly than mid caps. There is often limited information about small caps in the public domain and hence you must be willing to dig deeper.
5. When should I exit a mid- or small-cap fund/stock?
Should you sell a mid/small-cap fund or stock after it has done well? Should you exit after it has done poorly?
Well, neither, actually.
When it comes to exiting a mid/small-cap stock, you should do so in the following cases:
- The business fundamentals have deteriorated.
- The valuations have become too stretched.
- There are better options in the market.
- You need the money.
When it comes to exiting a mid/small-cap fund, you should do so in the following cases:
- The fund has been underperforming its benchmark or category for two years or more.
- You are nearing your goal for which you had been investing.
- You realise that you have wrongly invested in the fund and it doesn’t belong in your portfolio.
- You need the money.
So, you should not exit a mid/small-cap stock/fund based solely on its near-term performance. You should assess the underlying reasons and then only hit the sell button.
6. Which are the best mid and small-cap funds at the moment?
To find the best mid- and small-cap funds and also to find the best funds across categories, you can visit ET Money’s mutual fund section.
