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Time to look at midcap funds again?

Though few in the market expect an immediate rebound due to the slowdown, mutual fund advisors are asking their clients to accumulate mid-cap schemes with an investment horizon of three years.

, ET Bureau|
Updated: Nov 11, 2019, 09.12 AM IST
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“Midcap valuations are now supportive as they have corrected sharply and are closer to their pre-2014 levels,” said Kashyap Pujara, head of research at Axis Capital.
Mid-cap funds — laggards for the last two years — are back on investment advisors’ recommendation list. After the underperformance since January 2018 following the sharp drop in share prices, analysts are betting that their valuations have hit a nadir. Though few in the market expect an immediate rebound due to the slowdown, advisors are asking clients to accumulate mid-cap schemes’ unit for a three-year period. Franklin India Prima Fund, Kotak Emerging Equity Fund, Sundaram Midcap Fund and Invesco India Midcap Fund are among their top picks in the category.

“Risk reward is in favour of accumulating midcaps for investors with a three-year time horizon,” says Ashish Shankar, head (investment advisory), Motilal Oswal Wealth management. “Several mid-cap stocks have corrected significantly and are now reasonably priced.”

While the benchmark Sensex is at a life-time high, mid-cap indices are lagging behind. The Nifty Midap 150 is down 18 per cent from its high of 7469 in January 2018. Many stocks are still down 30 per cent-50 per cent.

The sell-off has resulted in valuations of mid-caps, measured by price to earnings (PE) ratio, fall below various long-term averages.

“Midcap valuations are now supportive as they have corrected sharply and are closer to their pre-2014 levels,” said Kashyap Pujara, head of research at Axis Capital.

For instance, the discount in PE ratio of mid-caps to largecaps is now at a 7-year high. The discount in price to book value (PB) ratio to large-cap is now at its 10-year mean and at a 20 per cent discount, said Pujara.

Before January 2018, mid-cap valuations were trading way above that of large-caps following the sharp run up in their prices from late 2013. Pujara points that between March 2015 and August 2018, the NSE Midcap Index performed as a higher-beta variant of the Nifty, registering 80 per cent higher returns. But, in the absence of earnings growth, valuations of most midcap shares had become expensive, resulting in the sharp sell-off from early 2018.

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Shankar of Motilal Oswal expects mid-cap shares to remain volatile in the near term as many are illiquid. He suggests sticking to midcap funds where fund managers have seen cycles and have a long track record. His top picks are Franklin India Prima Fund and Kotak Emerging Equity Fund and Sundaram Midcap Fund.

While earnings growth for the Nifty Midcap universe of companies fell by 13 per cent in 2016, 5 per cent in 2017 and 14 per cent in 2018, it picked up marginally by 1.9 per cent in the year 2019. Franklin Templeton Mutual Fund expects earnings growth for the Nifty Midcap 100 to be robust in the coming two years. Analysts estimate it to grow 113.9 per cent for 2020 and 20.1 per cent for 2021.

Analysts said low institutional ownership could act in favour of midcaps.

“While institutional ownership of Indian equities is at its peak valued at $700 billion, small- and mid-cap ownership within institutional portfolios has fallen by 600 basis points to 14 per cent from peak of 20 per cent in 2012,” said Pujara.

Analysts said over 34 per cent of the stocks in the Nifty Midcap index are tracked by less than 10 analysts. Wealth managers aver that investors could stagger their investments to mid-cap funds. “Low liquidity makes midcap stocks volatile and corrections could be very sharp. To make the best use of these corrections, investors could stagger investments over three to six months,” says Anup Bhaiya, managing director, Money Honey Financial Services, a Mumbai-based financial distributor.

His top picks in the space are Invesco India Midcap Fund and Franklin Prima Fund.

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