In previous blog, we discussed the performance of large-cap mutual funds and how active mutual funds failed to beat the index in the category. This made us think, what if, with little extra risk, you want to achieve additional returns than large-cap?
And we looked at mid-cap mutual funds to check whether it is possible.
So, let’s discuss what mid-cap mutual funds are, the performance comparison between active and passive funds, and let’s see whether investing in mid-cap is better than large-cap or not.
Estimated read time: 4 minutes and 32 seconds
Buckle up. Here we go!
What are Mid-Cap Mutual Funds?
In mutual funds, funds are categorized based on the size and type of companies they invest in.
Mid-cap mutual funds are equity funds that invest in the medium-sized companies of India. They primarily invest in the listed companies ranked between 101 and 250 based on their market capitalization.
Mid-cap companies, as the name suggests, lie between large-cap and small-cap companies. They have evolved from small-cap companies and are striving to become large-cap companies. These companies are some of the fastest-growing companies in India and are at a stage today’s leaders were a few years back.
Yes, Nifty 50 and Nifty Next 50 comes under Nifty 100 Largecap.
Active vs. Passive Mutual Funds
Active Mutual Funds: These funds are actively managed by professional fund managers who make investment decisions intending to outperform a specific benchmark index, such as the Nifty 50 or Nifty Midcap 150. The idea is to pick stocks that will generate higher returns than the index (alpha).
Passive Mutual Funds: Passive funds, on the other hand, don’t rely on active decision-making by fund managers. Instead, they aim to replicate the performance of a specific index. These funds simply mirror the composition of the chosen index. If the index goes up, the passive fund goes up. And if the index goes down, so does the passive fund.
If you want to learn more about active and passive mutual funds, read here.
Now, let’s dive into the numbers because when it comes to your hard-earned money, facts and figures are your best friends. Let’s look at how active large-cap funds have fared against passive index funds over the years.
Performance: Active vs. Passive in Mid-Cap Category
Historically, active mid-cap mutual funds have been a popular choice for investors seeking potentially higher returns than large-cap. Investors thought since these mid-size companies have better potential to grow, the returns would be high. And it is true. Over the years, the Nifty Midcap 150 Index have outperformed the Nifty 50 and Nifty 100.
But did the allure of having experienced fund managers make decisions on their behalf pay off? Nope.
As you can see, in the short term, over 75% of active mutual funds in the mid-cap segment failed to beat the returns of the Nifty Midcap 150. And in the long term, at 5 and 10 years, 50% of active funds failed.
Now, you might think 50% is not that bad. But the problem is the active funds that outperformed the midcap index only gave an average additional return of 2.3% and 1.1% in 5 and 10 years, respectively.
Also, only one active mutual fund has been able to beat the index in 1, 3, 5 and 10-year time frames consistently. Remember, past performance is no guarantee of future results. You can check out our analysis of mid-cap funds in this Google sheet.
Therefore, we don’t think the additional effort to find the best active fund in the mid-cap segment is worth it. Just like in the large-cap segment, focus on investing in index funds in the mid-cap segment too.
Why Should You Invest in Mid-Cap Funds?
Mid-cap funds offer unique advantages and can be a valuable addition to your investment portfolio for several reasons:
- Growth Potential: Mid-cap companies are often in a growth phase. They have passed the initial stages of small-cap volatility and are not as mature as large-cap companies. This positions them for potential growth opportunities. As of Oct 31, 2023, Nifty Midcap 150 has on average delivered 20.2% p.a. returns in the last 5 years. Their 3 and 10-year annualized returns are 31.9% and 20.9% p.a.
- Diversification: Sector-wise and company-wise, the Nifty Midcap 150 is more diversified compared to Nifty 100 or Nifty 50. This diversification spreads risk across various companies and sectors, reducing the impact of poor performance by any single company or sector.
- Risk-Reward Balance: Mid-cap stocks offer a balance between the growth potential of small caps and the stability of large caps. While they carry more risk than large caps, they are generally less volatile than small caps, offering a middle ground for investors seeking growth with some level of stability. NSE report shows that the Nifty 150 Midcap has a better return-risk ratio compared to the Nifty 100.
When Should You Invest in Mid-Cap Index Funds?
Investing in mid-cap funds can be a sound choice for you under the right circumstances. While active mid-cap funds might not be the best choice, mid-cap index funds offer a suitable alternative. Here’s when you should consider investing in them:
- Long-Term Investment Horizon: Mid-cap index funds are best suited for investors with a long-term investment horizon, a little longer than large-cap. Invest in mid-cap funds if you’re planning to invest for 7 years or more. Why 7 years? An ITI report shows that over 7 years, the probability of the mid-cap index generating negative returns is 0, and the generating returns over 10% is 99.9%.
- Risk Aversion: Evaluate your risk tolerance. Mid-cap funds are more volatile than large-cap funds, and your willingness to bear this higher level of risk should align with your investment objectives. If you have a high-risk tolerance and can withstand short-term market fluctuations, mid-cap funds might be suitable.
- Diversification: Diversification is a key principle in investing. If your portfolio is heavily concentrated in large-cap stocks or other asset classes, adding mid-cap funds can enhance diversification and reduce concentration risk.
Do you want to know how to pick the best Nifty Midcap 150 index fund? Read here.
In the world of mutual funds, the choice between active and passive funds can be confusing. Similar to large-cap mutual funds when it comes to mid-cap mutual funds, the data suggests passive index funds may offer a more straightforward and potentially more rewarding path for investors.
Investing in passive/index funds offers cost-effectiveness, stability, and a set-and-forget strategy, which aligns well with long-term investment objectives.
For beginners looking to get started with mutual funds, this approach simplifies the investment process and aligns with a long-term, low-maintenance strategy. It’s an easy way to get started without delving deep into the complexities of stock picking or navigating the unpredictable waters of active mutual funds.
Share these insights with your buddies. Until next time!
If you are like us, who likes to analyse a little more or check out content in different formats, well you are in luck. Below you can find some suitable content we found.
Note: We don’t have any affiliation with them. We are sharing links only for educational purposes. The opinions expressed by them belong solely to them and do not reflect the views of Vrid.