HSBC Midcap: Not good enough

To make the most of investment opportunities in stock markets, mid cap funds have always ranked high among risk-taking investors. Investors have observed on more than one occasion that mid cap funds can offer above-average growth potential vis-à-vis large cap stocks. However, the fact that usually gets ignored is that this growth comes at a price i.e. higher risk (more on this later).

Mid cap funds, as the name indicates, are mandated to invest (predominantly) in companies from the mid cap segment. The definition for mid caps, however, is not consistent across fund houses.

Personalfn's view on investments in mid/small cap stocks:

Mid cap companies tend to be under-researched ones, thereby providing an investment opportunity that is yet to be identified by the market. Investments in such companies offer high growth potential and the opportunity to clock above-average returns over the long-term (at least 3-5 years).

On the flipside, since mid-sized companies are often under-researched, there is a fair chance that some reasons for "not investing" could be overlooked. As risk control measures and corporate governance in these companies are evolving, the chance of manipulation in such companies is higher. Similarly, there is a possibility that the stock is illiquid even after considerable time making it an unviable proposition for the investor/fund manager.

The investment proposition offered by the NFO

HSBC Midcap Equity Fund, the fund under review, is HSBC Mutual Fund's mid cap offering. It was launched in April 2005 at a time when the NFO frenzy had just taken off.

According to the fund's investment mandate, companies from the CNX Midcap 200 Index are defined as mid caps. (The CNX Midcap 200 was the benchmark index at the time of the NFO; presently BSE Midcap is the benchmark). Likewise, stocks that fall within the market capitalisation of CNX Midcap 200 Index at the point of investment qualify as mid caps.

The fund is mandated to invest predominantly (at least 65 per cent of assets) in mid caps. Also, it has the flexibility to invest upto 35 per cent in stocks outside the CNX Midcap 200 but with a market capitalisation lower than that of the largest constituent of the CNX Midcap 200 Index.

At Personalfn, our view on a lot of the NFOs launched over the last few years is that investors should give them a miss and instead evaluate its performance (in the case of equity funds, since most NFOs belong to that segment) over the long term (3-5 years) and take a revised view accordingly. Till then we recommended that investors opt for existing funds with well-established track records.

Given that HMEF is close to completing three years of existence, now is a good time to evaluate its performance.

The face-off

(Source: Credence Analytics. NAV data as on March 11, 2008.)
(Standard Deviation highlights the element of risk associated with the fund. Sharpe Ratio is a measure of the returns offered by the fund vis-à-vis those offered by a risk-free instrument)

For the purpose of peer comparison, we have considered equity funds that are predominantly invested in midcaps and have been in existence for atleast 3 years.

Over the last 12 months, HMEF's NAV has appreciated by 24.2 per cent and trails most of its peers. Also, the fund has failed to match its benchmark index i.e. BSE Midcap (32.5 per cent) over this time frame. Since inception, HMEF has clocked a growth of 31.4 per cent CAGR (compounded annualised growth rate).

Volatility

Standard Deviation is a measure of the volatility in a mutual fund's performance; a lower Standard Deviation denotes lower risk. With a Standard Deviation of 9.20 per cent, HMEF has been an average performer on the volatility control front; ICICI Pru Emerging Star (10.86 per cent) fared the worst. Sundaram Select Midcap (8.57 per cent) delivers a competent performance on this parameter to emerge as the leader.

Risk-adjusted return

Sharpe Ratio evaluates how well the mutual fund has compensated investors for the risk borne (the risk-free government security is considered for the purpose of evaluation). HMEF (Sharpe Ratio 0.08 per cent) is the worst performer on the risk-adjusted returns front, while Reliance Growth (0.21 per cent) occupied the top slot.

As can be seen in the graph, Rs 100 invested in HMEF on inception (April 2005) would have grown to approximately Rs 189 by March 11, 2008, while the same amount invested in the benchmark index i.e. BSE Midcap would have been worth Rs 188.

In a nutshell. . . 

While equities should ideally be evaluated over at least 3-5 years, HMEF may need some more time to prove its worth in the investor's portfolio. However, its modest performance so far cannot be ignored. To investors who are enthralled with NFOs, the message is clear -- NFOs aren't necessarily a surefire way to beat the competition and the market. As a matter of fact, more often than not, we find NFOs trailing competition/market on risk and return parameters.

What should investors do?

Should investors consider investing in HMEF or liquidate their existing investments instead? Well, that would depend on the investor's risk appetite, investment objective and existing portfolio, among a host of other factors. At Personalfn, we have always maintained that a 'one size fits all' approach doesn't work while investing. An investment avenue that is apt for one investor could be grossly unsuitable for another. Investors would do well to consult their investment advisors/financial planners to determine the suitability of HMEF in their portfolios.

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