What's happening to mid and small cap funds? Why are they losing more and should you be worried?


Some of our investors who chose to invest under a 'high' risk profile have a couple of small and mid cap funds in their portfolios.

Recently, these small and mid cap funds have hit a rough patch so naturally some of our investors have asked us about what is happening and what's the forecast.

While I am not a big believer in market analysis (because knowing why markets have been down does not help in predicting their future course) and much less in market forecasts, my colleagues think it will be helpful for our investors.

So here goes.

First the facts.

(Returns as on 5th June 2018. Source: https://www.bloombergquint.com/markets/equities/historical-returns)

For the year, Nifty is almost flat (down since Feb) but mid caps (represented by NIFTY MIDCAP100) and small caps (represented by NIFTY SMALL 100) are performing much worse (-11% and -14% respectively).

High risk - high reward

One of the reasons is that in general small and mid caps are high risk-high reward investments so whenever the overall market goes down (up) they will go down (up) more.

We can see that in the table above with respect to longer time periods e.g. if you look at the 3 years or 5 years column, you will see Midcap and Small cap indices have done much better than Nifty.

So, it's a two way street - small and mid caps will go up more and they will go down more. You can't have one without the other, or the reward without the risk.

There is at least one more factor currently in play.

SEBI mandated categorization and rationalization of Mutual Fund Schemes

Last year, SEBI asked all Mutual Fund houses to clean up their fund offerings i.e. they were asked to have only one fund per category and ensure that the fund's portfolio follows the category.

Till now, even a large cap fund could hold a decent amount of mid and small cap exposure depending upon the discretion of the fund manager - which they did in order to boost returns.

But now SEBI has mandated that Mutual Funds should be true to their label i.e. a large cap fund should mainly have only large cap stocks in them.

Due to this there is some selling going on in the mid and small caps as all Mutual Funds which had 'unwarranted' midcap and small cap exposure are now getting rid of them in order to comply with their category norms.

Can there be more reasons?

Definitely. Stock markets react to all the information out there - from individual firm level information to global macroeconomic conditions. Most of the times, the reasons (or the purported reasons) are only known in hindsight (which is why I don't bother with market analysis).

Can we see a 2008 like crash soon?

Yes. No. May be. No one knows. Even in 2008 people did not think they were going to see a crash.

Sooner or later there will be a crash and you will have to sit through it. We won't see it coming. You won't see it coming. No one will (other than those who always think a crash is coming and hence never invest).

Which is why it is very very important to invest according to your risk profile. I cannot over-emphasize this.

What should I do?

If you are worried regarding your investments - that's a sign that you have probably taken on too much risk i.e. equity allocation is higher and debt allocation is lower than what it should be .

Take our risk profile questionnaire here to find out your risk profile and then adjust your investments accordingly. Reach out to us if you need any help in making the adjustments.

Another way to think about risk profile is this - Invest only that amount in equity such that you don't feel the need to track the markets.

Tracking the markets is a futile exercise - it does not make you a better investor, it only makes you a worse one and it's a sure sign that you have taken on more risk than you can handle.

I have a moderate risk profile and I invest according to that (check out my portfolio here). I don't track the markets or watch business news channels or follow all the economic developments and yet I have managed a healthy CAGR of more than 15% on my equity investments over the past 7-8 years since I started investing.

How? Because of my streak. I have a streak of 26 months on Goalwise now (and much longer than that before Goalwise)!

Invest according to your risk profile and don't stop investing. The rest will take care of itself.