Investing in Mid-cap Funds? Check out the risks involved

Introduction:

Equity Mutual Funds are a great way to get exposure to different market caps through one investment tool. Based on the market capitalization value, equity stocks are categorized into large-cap, mid-cap, and small-cap stocks. Different types of Mutual Funds allocate funds in different proportions across these sectors to achieve their objective. Off late, Mutual Funds that concentrate their portfolio towards mid-cap stocks are among the forefront performers. Today, let’s understand Mid-cap funds and their different aspects in detail.

Understanding Mid-cap Funds

Mutual Funds that concentrate their fund allocation into primarily Mid-cap stocks are called Mid-cap funds. SEBI has defined Mid-cap companies or stocks as those that rank from 101 to 250 on the list of companies according to their market capitalization value. In terms of actual valuation, Mid-cap companies lie within the range of approximately Rs. 5000 crores to 20000 crores. But, this range could keep on changing as market capitalization is calculated by multiplying the price per share and the total number of shares.

As compared to large-cap companies, mid-cap stocks are smaller in valuation, offer higher returns, and are riskier. Whereas in comparison to small-cap companies, mid-cap companies are larger, and more secure with a relatively lower growth rate. Hence, it is safe to say that Mid-cap funds possess a balanced combination of risk and returns.

Risks of Investing in Mid-cap Funds

Like most equity-based investments, there are 2 sides to investing in Mid-cap funds as well. Here are the risks that you should be aware of if you want to invest in Mid-cap funds,

Volatility

Mid-cap stocks mostly generate revenue from one main business line. More so, these companies cater to a small number of clients. This excessive dependency gives way to volatility risks when the markets are not so favourable. This especially holds when stocks are over-valued and the volatility in stock markets is at its peak. In such scenarios, Mid-cap stocks get affected severely due to drastic shifts in prices.

Limited Range

There are very few schemes that focus on Mid-cap funds. Investments do keep coming in Mid-cap funds, but as soon as the investments in this sector become voluminous, the Fund Managers are forced to pick stocks from the other two sectors due to the limited choice of well-performing stocks in the mid-cap category. Either the strategy then becomes to divert funds from the mid-cap stocks towards large-cap stocks that provide lower but stable returns or towards small-cap stocks that may seem promising in terms of returns but are very volatile. This dilutes the focus on Mid-cap funds.

Additional Read: How to Choose the Best Equity Mutual Fund

Benchmarking Issues

Sensex and Nifty are benchmark indices that reflect the sentiment of the market. It is easy to benchmark the performance of large-cap funds with these established indices as they are similar in terms of market capitalization value. However, there is no set index to benchmark the performance of Mid-cap funds. Mid-cap funds possess qualities of both large-cap funds as well as small-cap funds to an extent and this assorted feature makes it difficult to categorize and benchmark them.

Liquidity Issues

Mid-cap equity funds tend to offer better returns than large-cap funds if they are invested for a long tenure of 7 to 10 years. Hence, it is a good idea to park your funds here for steady growth in normal circumstances. But in case of a stock market crash or crisis, if you want to exit from your Mid-cap fund, it may be difficult to do so. This is because inherently mid-cap is riskier than large-cap funds and investors tend to stray towards more stable stocks such as large-cap stocks in a crisis. Hence, you may not find buyers for Mid-caps at such times and consequently, you could suffer huge losses.

Additional Read: 7 things new Mutual Fund investors need to know

Conclusion

Be a smart investor by defining your financial goals before you pick a Mutual Fund Scheme so that your end objectives and investment horizon match with the scheme. Each scheme comes with a set of risks, assess them carefully and accordingly concentrate on the right scheme and sector. If you are hunting for the best Mid-cap fund, look for a collection of well-performing, stable stocks that are led by a skilled Fund Manager. Remember to implement a balanced diversification strategy even when you pick the best Mid-cap fund to amplify your returns and hedge your risks.

Additional Read: Difference between large-cap, mid-cap, and multi-cap mutual funds