Bet or bait: As small & midcap funds re-open doors, should you invest?After a brief hiatus, small and mid-cap funds have started welcoming investors. In the recent past, many such funds had put restrictions on investor inflows. Now, they are again open for business. So, L&T Emerging Businesses Fund has allowed investors to invest lump sum as well as through systematic investment plans (SIPs) with no cap (earlier restricted to Rs 2 lakh a day).

We have already written about how DSP Small Cap Fund (the erstwhile DSP BlackRock Micro Cap Fund) is again allowing investors to start fresh SIPs and systematic transfer plans (STPs), though lumpsum investments are still barred. In May, IDFC Multi-Cap Fund (erstwhile IDFC Premier Equity Fund), reopened its door for lump sum investments. Similarly, SBI Small & Midcap Fund (now SBI Small Cap) had also reopened for subscriptions of SIP in May with a monthly cap of Rs 25,000.

There is no doubt that these funds have a stellar track record. It is equally credible that the fund-houses had the gumption and the conviction to tell investors at one point in time that flows need to stop. After all, who drives away investors! So, now when the same funds are telling investors to come back, the logical choice should be to invest. So, should you invest? Read on to know.

Funds speak

Investors in a mutual fund are relying on the fund manager’s skills and beliefs. Just like a doctor or a lawyer, fund managers make decisions on our behalf and tell us what to do. In MFs, we invest our money and experts manage it. Now with shares of small-cap and mid-cap stocks dropping quite a bit in the last one-year time period, no wonder many fund managers smell an opportunity. At a time when some large-cap stocks have given 20-70% return, there are dozens of midcap stocks that have crashed between 20-80%. In the small caps space, there are at least 100 stocks that have lost in the 40-90% range.

Clearly, the small and mid-cap funds, which have eased limits put on investors flows, think that valuations (or relative cheapness or expensiveness) of some mid cap and small cap stocks are better than they earlier were. Up until 2017-end, mid and small cap stocks saw huge investor interest. Stock prices in many cases went above justifiable levels, and literally, there was no stopping. But come 2018, that froth in such stocks was sucked out due to various factors like the imposition of long-term capital gain tax and funds being forced to streamline themselves after Sebi’s re-categorisation.

After a very sharp correction this year, mid and small cap fund managers see some value emerging in these stocks. If the fund manager’s conviction helped you gain previously, there is hardly any reason why you should not repose your trust in their decision-making abilities. Investment management is often built on the bedrock of complete trust. As an investor, you have to trust the expert. This is where investment advisors come in. In case you are not able to decide on your own, consult your investment advisor.

Asset allocation guide

Whether you want to invest in small and mid-cap funds is directly related to your asset allocation. Not all investors have the same risk profile. Hence, they need to have a personal touch to their portfolio. If you decided that large-cap funds will be 50% of your portfolio and the rest 50% will be split in 25-25% each in midcap and small-cap funds, review the situation.

If you want to invest in the small and mid-cap funds that have once again opened their doors, that decision should be guided by your equity asset allocation. Taking the above example, if the equity portfolio is still 50% large-cap, 25% mid-cap and 25% small-cap, you should resist the temptation to invest only in small-cap and mid-cap funds. To maintain the balance, invest in the 50-25-25 ratio in large cap, mid cap and small cap funds.

However, it is unlikely that mid cap and small cap funds allocation in your portfolio will be at the pre-decided asset allocation level. Because when a steep correction happens, the value of those fund investments also falls. This means typically your mid cap and small cap funds exposure is below the desired asset allocation level. As an existing investor, if you had invested Rs 2 lakh (10% of overall portfolio) in small-cap funds, a 20% correction would mean that the value of those investments would be Rs 1.6 lakh or 8% of the overall portfolio. So, you may have room to add 2% more and take it back to 10%.

Be long-term

Mid-cap and small-cap funds rarely deliver results in 1-2 years. This is because these funds invest in mid and small cap companies which take time to deliver growth. Yes, they often grow faster than large companies but nothing happens overnight.

Investors, who want to take advantage of easier fund investment restrictions in mid cap and small cap funds, must take a long-term approach to fresh money deployment. It is important to be selective and cautious. Generally, small and mid-cap funds take 5-7 years or even more to deliver superb returns. So, you need to be a lot more patient.

When the fund manager of a small-cap or mid-cap fund is taking a 10-year call, investors who take a 3-year call will always end up being disappointed. So, it is extremely vital that your time horizon matches with the fund manager.

Lastly, always adopt the SIP route to deploy money in equity MFs. Besides being good for cost-averaging, SIP investing makes you disciplined and mature. Also, by deploying investments over long period of time, you can understand that time spent in the market in mid and small cap stocks is better than timing the market.

Staff Writer

This article is written by RupeeIQ editorial staff.