Your equity diversified mutual funds must have generated attractive returns for you over last six months. As markets are rising incessantly to touch new highs every week; Net Asset Values (NAVs) of mutual funds are also rising. However, performance of all funds is not alike. On an average, largecap oriented funds have generated about 18.2% returns over last 6 months. Returns generated by multi, flexi and opportunities funds have averaged at 21.3% over the similar time period. The best performing category has been that of midcap oriented funds. The average returns generated by the category of midcap oriented funds have been 31.0%. This indicates that, midcap focused funds have outperformed by a substantial margin. Investment strategies and market capitalisation preferences have made a significant difference to the returns generated by various mutual funds.
 

Outperformance of midcaps over largecaps

Data As on March 28, 2014
(Source: ACE MF, PersonalFN Research)  

S&P BSE sensex has generated 13.2% returns over last six months whereas S&P BSE Mid-Cap has generated 24.7% returns over similar time period.

Why are fund managers bullish on midcaps?
You must be aware about factors that are supporting the current market rally but might be wondering why largecaps are underperforming with such a big margin. The outperformance of midcaps is largely on account of attractive valuations in midcaps vis-à-vis those in largecaps. Aggressive buying by Foreign Institutional Investors (FIIs) has helped markets sustain rallies. When markets sustain rallies and valuation difference between largecaps and midcaps (known as P/E spread) widens, midcaps see buying interest. This is what we have witnessed over last few months. However, it is noteworthy that only few stocks are driving the midcap indices and unlike S&P BSE Sensex, S&P BSE Mid-Cap is far from its all-time high. December quarter results suggest that earnings growth has been tepid in mid-sized companies. Midcaps that are rising in the current rally are either expected to see improvement in revenue and profit growth in future or they were severely beaten down which made them attractive even for slightest improvement in the fundamentals. Stock selection has mattered a lot in the performance of diversified equity funds. Difference in the returns generated by the top performing and the worst performing largecap fund is about 18% on absolute basis. However, that for top performing and the worst performing midcap fund has been around 32%. This suggests that, stock selection has played a crucial role in the returns generated by mutual funds, specifically in midcap funds. As far as performance of multi-flexi and opportunities funds goes, those with high mid and small cap exposure have outperformed the ones with lower midcap exposure.

PersonalFN believes that investors shouldn’t get lured by the returns that funds have generated in the current rally. A detailed analysis suggests that, funds which have generated unparalleled returns in the on-going rally, have by and large been underperforming across timeframes except for the last 6 months.

PersonalFN believes that, markets may continue to remain firm until election results are announced. If results are contrary to the general belief that, NDA will form the new government and stimulate economic growth, FIIs may start pulling out money. In such case, midcaps may fall sharply. Those who are buying midcap stocks on rallies may then find it difficult to deal with market sell-offs. This is also true in case of fund houses as well. PersonalFN suggests that those who are stuck with inconsistent mid and small cap oriented funds would be better off redeeming them now. PersonalFN believes current market rally provides good exit point. It is imperative to select a mutual fund wisely. Recent performance doesn’t tell you much about quality of returns generated by the fund.

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