Is it time to invest fresh money in small- and mid-cap mutual funds?

Pick small-caps with growth opportunity

The fact that mutual fund managers are willing to accept fresh flows after a while indicates that investment opportunities are emerging again. That they are still curbing the amount through systematic investment plans (SIP) indicates that some caution is still required. We observe that there is far greater differentiation among mid-cap and small-cap funds as against large-cap funds. This is because the number of listed companies in this space is far more, leaving fund managers with greater choice. Their relative skill is more on display here.

The point is that investors need not bracket all small-cap funds alike but learn to pick out those portfolios that show growth opportunities from here on. For instance, there are some fund portfolios that have a favourable price-earnings to growth (PEG) ratio. SIPs or STPs in funds that are fundamentally stronger are acceptable.

We are willing to move from an underweight position in mid-cap and small-cap to normal weight, but in a graduated fashion as macro risks are heavy for equity as a whole. This category has the potential to outperform if investors are willing to give it a longer term than one would give large-caps and accept greater drawdowns. —Srikanth Bhagavat, managing director, Hexagon Capital Advisors Pvt. Ltd

ALSO READ | Should you invest in midcap mutual funds now?

Use volatility for long-term goals

Over the last six months, there has been under-performance in small- and mid-cap funds. But a long-term investor should ignore this short period of under-performance and continue to invest through SIPs and STPs in small-cap mutual funds. Some funds have reopened their doors for investment. Investors should choose carefully and invest in these.

Use this volatility in your long-term journey to accomplish financial goals. I think interesting return opportunity always exists in small-cap funds. Having said this, investors should have a part of their portfolio in small cap funds. These funds are usually packed with businesses in their early stage of development with high growth rates. With new sectors evolving, these funds get the opportunity to invest and participate in the journey of small to mid to large growth over the next 10-15 years. There might be sluggish periods but the bounce back is normally quick. I think investors should rethink their small-cap allocation and not go by the recent fall. — Ravi Kumar T.V., director, Gaining Ground Investment Services Pvt. Ltd

ALSO READ | Is it time for you to shift from large-cap to passive mutual funds?

Important to look at the size of fund

The mutual fund landscape has changed totally after recategorisation. Sebi now classifies stocks ranked 251 and above in market capitalisation (at today’s value, ₹ 9,000 crore and below) as small-cap; earlier funds used a much lower market cap as the cut-off. Fund managers now have a larger basket to choose from.

The fall in valuations is also drawing investors, but have a time horizon of at least five to seven years. However, do look at the size of the fund. As the corpus increases, fund managers will require to increase their basket of stocks they invest in to prevent against liquidity risks. This will reduce the possibility of alpha, or excess returns versus the index generation.

When many PMS (portfolio management scheme, licensed by Sebi where the minimum investment is ₹ 25 lakh) providers stop accepting investments at ₹ 500 crore to generate returns, how can mutual fund schemes generate alpha with scheme sizes of ₹ 5,000 crore or more? Even if they do, for how much longer? — Lovaii Navlakhi, managing director and chief executive, International Money Matters

ALSO READ | Here’s how to pick a mutual fund from 14 new Sebi categories

Invest in SIPs, pick right time horizon

Is it time to look at small-cap funds? The answer would depend on how long you plan to invest for. If the investment horizon is a few months to a year or two, one can say with reasonable certainty that it’s not a good idea. Equity in itself is a long-term investment asset class, more so in case of small-cap companies (or funds). A popular small-cap fund recently boldly (and refreshingly candidly) advertised the fact that in the past it lost 67% value in one year. Talk about volatility! And the kind of investor that it takes to sit through this phase.

And about the recent correction, who knows if it is deep enough or that small-caps would bounce back and make new highs. Since almost all these levels or events can’t be predicted, instead of choosing the “right time to invest”, let’s pick the “right investment horizon”. The real benefit of small-cap investing kick in and consequent wealth creation will take place over such long horizons and across market cycles.

Want to do better? Go for SIPs; after-all the SIP in the same fund that did pretty badly in that 1-year period, has delivered compounded returns of 22% over the last 11 years. —Amol Joshi, founder, PlanRupee Investment Services

ALSO READ | Mint 30: The best mutual funds to invest in