In recent times, the media has written a lot about mid-cap 'rallies.' The common misconception formed by many is that mid-caps are a short-term story, and not for serious long-term investors, and moreover, that the mid-cap 'story' is over.
But let's first understand what a 'mid-cap' is.
Market capitalisation, or 'market cap', refers to the company's value, as measured by the product of a company's shares multiplied by the share price. Based on market capitalisation, companies can be divided into small-cap, mid-cap and large-cap -- the three stages of a company's life cycle.
Most companies start off small -- in fact, any new industry typically starts off as fragmented, with many small companies competing for the available business.
This is a high-risk period for these companies. Over time, some of them get taken over, some just can't compete, and only a few go on to the next stage of their life cycle: the mid-cap stage.
Having survived the small-cap stage, the mid-cap stage sees companies embarking on a period of long-term, rapid growth. In fact, mid-cap companies grow faster than others.
On their growth path to becoming large corporates of tomorrow, these companies can rapidly grow their sales and profitability and scale up their businesses sustainably, generating great returns consistently for a long period, until they become stable large-caps.
This high growth rate is a function of two things. The first, of course, is that there is real growth -- mid-cap companies are in the process of scaling up their businesses, growing into larger opportunities.
The second is that this growth is on a small base -- which makes the rate of growth higher. By the time these companies become large-caps, their growth rates are smaller, and they're less volatile -- offering investors stability in place of rapid growth.
So what has made investors believe that mid-caps represent a short-term story? Possibly mid-caps' volatility: when markets rise, mid-caps rise faster than large-caps, but when markets correct, mid-caps fall more than large-caps.
Viewed over short periods of time, these periods of growth followed by corrections could be seen as 'rallies' by the market -- but a longer-term view of mid-caps will show that though they react to market events, they can experience significant long-term growth.
And to truly benefit from mid-cap investments, one should stay invested for the long-term.
Mid-caps can be found across sectors -- allowing mutual fund houses to create well-diversified mid-cap portfolios, and reducing risk for investors.
This makes mid-caps an all-seasons story; while individual mid-cap stocks may be affected by market conditions, it is possible to build a portfolio of mid-cap stocks that will thrive irrespective of market movements.
Interestingly, the developing Indian economy is uniquely positioned to nurture mid-cap growth. As our economy transitions, it opens up new business opportunities and sectors -- which spawn new mid-cap companies. And as these sectors mature, some mid-caps in these sectors will grow into mature large-caps, and other sectors and opportunities will emerge -- providing a stream of mid-cap investment opportunities.
And, of course, there are many more mid-caps to choose from than there are large-caps. As compared to about 50 large-caps, there are close to 200 mid-caps -- many of them poorly researched. There is a huge opportunity for gain by identifying the right companies before the market, and then investing in them for the long haul.
People keep asking, 'But isn't the mid-cap story over?' We don't believe so. Over recent years, the mid-cap indices have performed exceedingly well, and mid-caps have come into the limelight. But the amazing growth they have shown in the recent past doesn't preclude their long-term future potential.
I believe that there are still good returns to be made from mid-cap stocks, and better returns still if the right stocks are chosen -- in fact, in light of the number of mid-cap stocks in the market today, the potential for good fund management by selecting the right stocks, we firmly believe this is an excellent time for investors to enter mid-caps, through the mutual fund route.
Mid-caps have done exceedingly well in relation to broader markets over the past few years, and present a good opportunity to investors to increase their returns. I would strongly recommend to investors to take some mid-cap exposure as a part of their larger portfolio.
Ideally, I would encourage investors to invest in mid-cap mutual funds, with a fund house they trust, or that has proven expertise in stock picking, which will be an important factor in good returns in mid-cap investments.
The author is CEO, Kotak Mahindra Mutual Fund.
Disclaimer: Investors should carefully read the prospectus and make investment decisions based on their own objectives and resources, and consult their financial and legal advisors before making a decision to invest.
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