Is the outperformance of small and mid-cap funds sustainable?
Small and mid-cap funds being at the base of the hierarchy of the funds that are based on market capitalization and thus they constitute an important part of one’s mutual fund portfolio. Even the best mutual funds which have performed well in recent are the funds from the small and mid-cap funds category as they intend to give higher returns in a short period of time.
But can one totally rely on them and is the outperformance of these funds in comparison to large-cap funds sustainable is the question in the mind of each investor.
The markets suffered the most in September 2012 when the small and mid-cap funds were at their record lowest owing to inadequate demands and higher leverage putting pressure on companies. But Small-cap stocks and mid-cap ones have totally outperformed large-cap funds after the market lows during the financial crisis. Between 2014-2015 the small and mid-cap mutual funds became the best performing delivering a 30 % return in the equity funds category. Whereas large-cap diversifies funds just recorded a 14 percent return.
Why this outperformance was seen in the markets by small and mid-cap funds?
The great performance of these funds was owing to two reasons –
- When the economy started regaining its pace small and mid-cap funds companies had faster recovery as they constitute the bottom of this market hierarchy. So, they had some great cash flow to support their working capital needs, debt, and interest rate reduced leading to faster revenue generation.
- The stock prices of these companies went up as when the market is stabilizing again domestic participation also increases which ensures an increase in the capital flows with these companies.
So, the supply of funds and investing took place where there were great opportunities for growth. But then again, a discussion has aroused in the market that how reliable this outperformance is in the coming years. The studies depicting that if one has high-quality small-cap and medium cap funds in your portfolio which are the securities that have shown profit growth, safety, and a high pay-out, they will still outperform the large-cap competitors and are thus are sustainable for investing.
Things to keep in mind while buying mutual funds in the coming years pertaining to small and mid-cap funds:
- You should be thinking to invest in the small and mid-cap companies because they are good investments having valuations on the higher side.
- But in spite of the small-cap index increasing largely and the tremendous opportunities they possess, extra caution needs to be given due to the higher risk associated with these.
- One should be selecting companies that are active in growing markets, based on their management i.e. highly dynamic and innovative capabilities.
- Small-cap stocks should also be considered as they have a higher proportion of domestic revenue and thus they can easily benefit from a strong local economy.
- One should be investing in funds that have a low turnover ratio (less than 0.5) and those which have performed through various life-cycles.
- Moreover, if you are thinking of investing for a long horizon of time, you can invest in mid-cap funds for sure.
The basic assumption says that the economic recovery can last for another five years, earnings growth is expected to show higher returns as the market is also expecting 15% approx. earning growth. So, you can go for a 25-30 percent investing in small and mid-cap funds in your portfolio and expect a higher return.
