NFO review: Union Midcap Fund aims to strike balance between growth and bargain stocks

The new fund offer opened on March 2 and will close on March 16; fund to be managed by Vinay Paharia and Hardick Bora

Kumar Shankar Roy Mar 4, 2020

Principal Midcap FundUnion Mutual Fund, co-sponsored by Union Bank of India and Dai-ichi Life Holdings, Inc. of Japan, has unveiled Union Midcap Fund, an open-ended equity scheme predominantly investing in midcap stocks. The New Fund Offer (NFO) opened on March 2, 2020 and will close on March 16, 2020. The allotment would be on March 23 and it will re-open for continuous sale and repurchase on March 30. Union Midcap Fund joins the 26-member existing midcap fund space. Midcaps are typically associated with high growth potential but they also come with higher volatility, especially in the short term. Today, valuations have been attributed as one of the main drivers for buying midcap portfolios. How will Union Midcap Fund build its portfolio? What will it do to control the volatility associated with midcaps? Read on to know more.

Midcaps – Are they for you?

Midcap businesses (companies) are generally characterised by stronger growth as compared to their larger counterparts. They also tend to be
more volatile in comparison. This makes them riskier in terms of volatility/returns.

Bear in mind a few things. In most cases, a midcap business may be a good business but it still has room to grow. To grow big, companies go through a process of transformation. Not all midcap companies end up as large businesses. That is why there is a risk. Only a handful of companies grow to become large. The rest languish. If your portfolio has companies that successfully go from midcap to large, you become rich. If things don’t go as plan, you can lose money.

Union Midcap Fund

Equity markets and mutual funds offer you different products. You need not be anchored towards just one category. In equity asset allocation, midcaps should be an essential part of investor’s portfolio based on risk return trade off. There will be largecaps, midcaps and smallcaps.

Midcap funds are not the only way to get growth. You can also take exposure to midcaps through multicap portfolios, large & midcap portfolios.

In India, midcap stocks are those that rank 101st -250th company in terms of full market capitalisation. So, there are 150 stocks that qualify as midcaps. At present, the midcap stock range is between Rs 8,000 crore to Rs 25,000 crore full market capitalisation.

To be a midcap fund, a equity scheme should invest 65% of total assets in equity and its related securities of midcap firms. The rest 35% can be used to invest in midcaps, largecaps, smallcaps or a combination of them.

Stock selection crucial

Out of 96 midcap stocks studied, 24 stocks went on from midcaps to largecaps, with average return of 25% CAGR. 72 stocks turned from midcaps to smallcaps, with average return of -13%. As you can see some of the stocks from midcap category tend to grow at faster rate, eventually becoming large caps. However, many stocks from this category may underperform and become small caps.

Hence, stock selection is very critical for which it is essential to have a robust investment process. The investment process is the secret sauce. Let us see what Union Midcap Fund offers in this respect.

Union MF divided the investment process into two broad baskets: 1. Stock Selection and 2. Portfolio Construction

Stock selection begins by defining an investment universe, where stocks with a market capitalisation of more than a defined threshold exist. Then, Business-Management-Valuation (BMW) filters are used to arrive at the fund-house universe. Stocks are then segmented into growth stocks and bargain stocks.

Growth stocks are where sales growth is greater than nominal GDP growth, where there is fast growing intrinsic value (of company), where the current price may be closer or higher than intrinsic value, and where stock returns mostly come from earnings growth. In the BMV context, growth stocks are where B and M are strong and V is fair.

Bargain stocks are where sales growth is lower than nominal GDP growth, where there is slow growing intrinsic value, where the current price has to be significantly lower than intrinsic value, and where stock returns mostly come from (valuation) multiple re-rating. In the BMV context, bargain stocks are where M is strong, V is cheap and B is fair.

Union Midcap Fund fund managers Vinay Paharia and Hardick Bora will aim to strike a balance between growth and bargain stocks.

Fund-house speak

G. Pradeepkumar, CEO, Union AMC said: “Midcaps are typically associated with high growth potential but they also come with higher volatility, especially in the short term. Some of the stocks from the Midcap category tend to grow at a faster rate and eventually become Large. However, there are many companies in the midcap segment which falter and fail to grow. Hence, stock selection becomes a crucial factor while managing a mid-cap fund. This is where the robust investment process followed by Union Mutual Fund plays a vital role. It helps us to ensure that we pick up high quality companies at reasonable price. Having the right allocation to midcap funds can enhance the overall returns of one’s portfolio.”

Midcap fund category returns

Midcap funds must be given atleast three to five years to show their true mettle. Midcap companies cannot become largecap companies in a year’s time.

If you look at midcap fund returns, they are also a function of market returns at that time. Today, the best-performing midcap funds on a 3-year time period are Axis Midcap (16.4%), Invesco India Midcap (11.04%), Tata Midcap (9.2%). The laggards are SBI Magnum Midcap (1.85%), Motilal Oswal Midcap 100 ETF (2.26%) and Aditya Birla Sun Life (ABSL) Midcap (2.31%).

In the 5-year period, DSP Midcap (10.7%), Axis Midcap (10.44%) and Kotak Emerging Equity (10.41%) are the top winners while Baroda Midcap (1.11%), PGIM India Midcap Opp. (4.85%), and Quant Midcap (4.96%) are the laggards.

Union Midcap Fund facts

Type of scheme – Midcap fund

Application amount – Minimum application amount is Rs 5,000. Minimum additional investment is Rs 1,000.

SIP – Monthly frequency is Rs 2,000 and for a minimum 6 months. Quarterly frequency is Rs 5,000 and a minimum of 2 quarters. SIP date can be any date of the month, but default date is 8th of every month

Entry load – Nil

Exit load – 1% if units are redeemed or switched out on or before completion of 1 year from the date of allotment of units. Nil if units are redeemed or switched out after completion of 1 year from the date of allotment of units.

Benchmark index – NIFTY Midcap 100 Index TRI

RupeeIQ take

Midcap funds are supposed to deliver better returns than largecap funds. The trade-off is higher risk than largecap funds. There will be years like 2018 and 2019 when midcaps will struggle against largecaps, which are a safe refuge. However, quality midcaps will always be safer than an average midcap stock. This is where stock selection and portfolio construction come. If you believe that Union Midcap Fund can deliver an all-weather proof midcap portfolio, go ahead and invest. Valuations of midcap funds are cheap as well at present, which make them a better buy than times like 2017 when valuations reached bubble-zone.


Kumar Shankar Roy

Kumar Shankar Roy is contributing editor with RupeeIQ. Kumar is a financial journalist, with a functional experience of 15 years. He tracks mutual funds, insurance, pension, PMS, fixed income/debt and alternative investments markets closely. He has worked for The Times of India, The Hindu Business Line, Deccan Chronicle Group, DNA, and Value Research, among others, across different cities in India. He is deeply interested in marrying data insights with actionable opinion. He can be contacted at [email protected].

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