Prime Recommendation: An index to challenge midcap funds

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For investors preferring to go the passive route, options were limited until recently. With the passive landscape changing now, it’s becoming increasingly possible to build a diversified portfolio using just passive strategies. And by this, we mean allocations to large-caps, multi-cap and even mid-cap and small-caps.

If you are a passive-only investor, you could simply stick to the options available. But at PrimeInvestor, we constantly watch for passive products that begin to challenge active funds.  In the large-cap space, the trend is very clear. In the mid-cap and small-cap space, active funds have usually had no trouble being to beat the indices. This, though, appears to be changing now – both due to fund performance and index options.

The index here is the Nifty Midcap 150 index. This is a relatively new index, sporting an April 2016 launch date. The index is constructed based on free-float market cap. It houses the 101st to 250th stock in terms of full market capitalisation – what SEBI defines as the stock universe for mid-cap funds.

  • The Nifty Midcap 150 is able to stay ahead of mid-cap funds with reasonable consistency in both 1-year periods and longer 3/5-year periods.
  • Its average returns across timeframes are better than the average for mid-cap fund category; i.e. many mid-cap funds have fallen behind the Nifty Midcap 150.
  • Several mid-cap funds are also finding it hard to match the Nifty Midcap 150 during upsides. However, funds have typically contained downsides very well, and fall much lesser than the index.
  • Holding the index is similar to holding the entire mid-cap universe. For investors keen on passive options, the Nifty Midcap 150 is a good route to mid-cap allocations. For other investors, the index still provides a good diversifier to counter the ups and downs mid-cap funds go through. This is especially true in the context of Indian midcap funds often falling by the wayside after a few years, requiring you to review and rejig your portfolio. In other words, a buy-and-hold-for-life midcap fund is hard to identify.

Holding the index is similar to holding the entire mid-cap universe. The index is constructed based on free-float market cap. It houses the 101st to 250th stock – what SEBI defines as the stock universe for mid-cap funds.

The index fund that mirrors the Nifty Midcap 150 is Motilal Oswal Nifty Midcap 150 index fund, and is part of our Prime Funds. This fund is new, being launched only in September 2019. It is also the only index fund to be tracking this index.

Index vs funds – performance

We haven’t gone too far back in time to look at performance. One, fund behaviour and the market was entirely different. Two, SEBI’s new category definitions came into force only in 2018 and to that extent, the Nifty Midcap 150 index (Midcap 150) is a good proxy for the midcap space primarily owing to this definition. Three, funds across categories in the past have not faced difficulties in beating the market. The struggle is a more recent phenomenon.

Therefore, we considered rolling 1 year and 3 year returns in the past six-year period. On a 1-year rolling return in this period, the Midcap 150 TRI was able to beat mid-cap funds 60% of the time on an average. Looking at mid-cap funds individually, only 5 delivered returns better than the index with a high degree of consistency.

Stretching the timeframe to a 3-year rolling return in a six-year period, the Midcap 150 TRI beat out mid-cap funds 80% of the time. Even going farther back to an 8-year period of considering 5-year rolling return, the index still managed to beat mid-cap averages more than half the time.

The table shows the average of the Midcap 150 TRI’s returns across different timeframes against the average for the mid-cap category since Jan 1, 2015.

Then consider upside capture – that is, how much of an index’s upside a fund is able to capture. On this metric too, only about 4 in 10 funds rose higher than the Midcap 150 based on 1-year rolling return over the past 5 years.

Index vs funds – downsides and volatility

Though mid-cap funds faltered on upsides, they scored during market falls. In mid-caps, falls can be steep. Recovery in this segment also comes with lag after large-caps recover and therefore slumps can be hard. Containing falls is one aspect where mid-cap funds have done very well.

Mid-cap funds’ ability to keep a lid on losses shows up in return volatility; mid-cap funds are actually better than the Midcap 150 TRI on this count

Using the downside capture ratio, all mid-cap funds kept their losses less than the Midcap 150 TRI. On an average, the category captured about 96% of the Midcap 150’s fall based on 1-month market movements over the past 3 years. And that means, on corrections, the Midcap 150 is going to fare worse than your fund.

For example, the index is currently sporting a 9.75% loss. The mid-cap category, on the other hand, is down by 6.5%; many funds have even smaller losses. This ability to keep a lid on losses shows up in return volatility; mid-cap funds are actually better than the Midcap 150 TRI. Active funds in other categories are usually more volatile than their benchmarks.

But owing to general performance, the Midcap 150 still ekes out a better risk-adjusted return.

Quick facts on the Nifty Midcap 150

Index vs funds – suitability and usage

The Midcap 150, in a nutshell, has the ability to deliver better returns than most active mid-cap funds but is more volatile and can fall more. So who should use the fund and how?

  • For passive-only investors who want to build a portfolio using a variety of indices, the Midcap 150 is a good fit. The index offers exposure to the entire mid-cap range. It can be paired with large-cap indices such as the Nifty 50 or the Nifty 100 for a diversified portfolio. However, if your portfolio also contains the Nifty Next 50, note that your portfolio volatility is already going to be high. In such a case, allocate a smaller share to the Midcap 150.
  • Investors who are looking for a different option in the mid-cap space can also use the Midcap 100 index. Mid-cap funds follow a bottom up approach, hold a limited number of stocks, and have higher concentration in individual stocks. The Midcap 150 index is different from these and to this extent, can provide diversification. Given that quality mid-cap funds score in containing losses, while the Midcap 150 scores on upsides, pairing such funds can balance a portfolio.
  • Investors who are wary of growing AUMs pulling down a mid-cap fund’s performance, can make some allocations to the fund.

Note: The index fund that tracks the index, Motilal Oswal Nifty Midcap 150 (explained below) currently has a small AUM as it is a new fund. While this can grow over time, allocating high share to the fund can be avoided until size picks up and tracking error more firmly established.

Next, given the current market scenario, either run SIPs in the Midcap 150 or make staggered lump-sum investments. While markets have recovered from the sharp sell-off in the earlier months, more falls as the full economic impact of the lockdown unfolds cannot be ruled out. Remember also that mid-caps in general need a high risk appetite and a long-term timeframe.

Which fund to buy?

For the Nifty Midcap 150, there is only one index fund and that’s Motilal Oswal Nifty Midcap 150. The fund was launched only in September 2019. In this limited history and using different timeframes such as 1-week and 1-month rolling returns, the fund has more or less been able to track the Nifty Midcap 150 TRI. When it lagged the index, the margin is about 20 basis points on an average. This can reduce over longer timeframes and as the fund grows. Its current AUM of Rs 44 crore is a leap up from the Rs 24 crore it was six months ago.

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Please note that any specific queries on any of our recommendations will be answered ONLY through email. If you are a subscriber, please mail contact@primeinvestor.in.  Only general queries or discussions will be answered through the comment section of the blog. For full details, please refer to this post – How to communicate with PrimeInvestor.

13 thoughts on “Prime Recommendation: An index to challenge midcap funds”

  1. Hi Bhavana
    The said MO Midcap 150 index fund has completed one year. The AUM is still around Rs.55 Crs. How do you see this? How is the performance of the fund compared to its benchmark (tracking error etc)? The TER is still better than some Next 50 index funds, probably to accumulate AUM.
    Any update would be helpful.

    1. Hello sir,

      AUMs will grow slowly. This is a relatively new fund and one that will not be actively pushed. But for all that, for it to have grown from Rs 20-odd crore at the time of launch to Rs 50 crore now is reasonably good. There are plenty of large-cap index funds that have been around for a long time and are still languishing at sub-Rs 50 crore levels. As far as tracking error goes, the fund is slowly bringing it down. It’s still slightly higher than a Nifty 50 index fund tracking error, but that’s somewhat expected.

      Thanks,
      Bhavana

  2. Hi , Bhavana !

    Very illustratiously explained . But , I am now having doubts or in two minds , whether to invest in the active funds or these ETFs . Also due to dmat facility easily one can sell . What is your opinion on going all for ETFs.

    Thanks and Regards,
    Makarand Tatje

    1. Hello sir,

      Active funds are not a complete write-off yet 🙂 Please read our article on this topic. You can mix passive and active options to build a portfolio that covers the better investment opportunities. Passive investing is done through both ETF and index funds. Which option depends on which index you need to invest in – some are only available in ETFs. It also depends on how comfortable you are with managing a portfolio that’s a mix of MF and ETFs. There’s liquidity in index fund too – it’s not that you will find it hard to redeem. We have covered index vs ETF in this article.

      Thanks,
      Bhavana

  3. Dear Bhavana
    Good article. Thanks.
    As suggested above, it would be good to learn from you about NN50 index v/s Midcap 150 index. While there is no overlap, the Return and Risk (volatility) are similar for both, especially when compared to Nifty 50. Any comments would be helpful.

    1. Bhavana Acharya

      Hello sir,

      Both indices are high volatile and high returning. But how much to allocate to one or both indices depends on your portfolio and risk level. There is nothing wrong in holding both the indices or either individually.

      Thanks,
      Bhavana

  4. Deepesh Mehta

    I read all your articles. But this article is not rightly compared. Why do you have to compare Average return of midcap funds across industry and highlight that index does well. If this is the right way to compare then, there should be no recommended list across midcap funds under primeinvestor.in. An investor can choose index fund across LC, MC, MuCap, SC and he doesn’t need primeinvestor research, a financial advisor to help him to invest.Just index funds would do for him.

    Moreover, SEBI classification came in Jan 2018. Any comparison before that time is not right.

    1. Bhavana Acharya

      Hello sir,

      Yes, just looking at the average would not be complete. But we have looked at returns of individual midcap funds and the index, in returns, upside and downside and seen how many beat the index and how often. This is explained in the article. Just the table shows the average of the category versus the index.

      Again, you are correct in that prior to 2018, categories were different. It’s one of the reasons we haven’t gone too far back in performance to see how funds behaved versus the index; we’ve gone back until 2014. For midcap funds, many of them already followed a classification somewhat similar to SEBI’s – if anything, they had far more held in (today’s) small-cap stocks which would have actually helped performance in the period we have taken. Further, as noted in the article, this phenomenon of midcap funds trailing the Nifty Midcap 150 is recent. So both fund performance and the index are comparable.

      While there are good index options, do note that we’ve also said this can be used in addition to active funds. There are mid-cap funds that beat the index yet. We’ve looked at index replacements in select categories only. There is space for index investing, but it still is not going to replace active funds. There are, and will be, quality active funds that beat the market and where indices cannot compete. We’ve talked about this here.

      There’s more to investing and building a portfolio that just a few index funds. Allocations matter. Blending funds (and even indices) that behave differently in the right proportion is important. Understanding equity markets and debt markets, reviewing a portfolio…all these are just as important as selecting the right funds.

      Thanks,
      Bhavana

  5. Praveen Kumar

    Hi,
    Can you also elaborate how close is this index fund to NN50? What if someone holds NN50 should they also consider this index fund?
    Regards, Praveen

    1. Bhavana Acharya

      Hello sir,

      There’s no overlap. The Next 50 has the 50 companies after the Nifty 50 – essentially until the 100th stock. The Nifty Midcap 150 is the 101st to 250th stocks. You can hold both indices. Just be aware that the Next 50 is more volatile than large-caps typically are, when you are making your allocations.

      Thanks,
      Bhavana

  6. Nellore Vittal

    Hello Bhavana,
    Excellent deep dive analysis. You have done a wonderful comparison. Full marks to you all. I am so happy with all your analysis and my decision to subscribe to your services. Till now I was always under the impression that it is better to be in Midcap active fund and not the passive fund. Your analysis has changed my perspective. It will be wonderful if you could do a similar comparison between Motilal Oswal small cap index fund vs small cap active funds. It may be worth while to see the comparison.

    In both Midcap and Small cap active funds, it is very difficult to know if we have picked the RIGHT FUND. If the chances of beating the index is low, then might as well invest in Index fund and forget about it. All my large cap funds I have shifted to either passive fund or ETF’s.

    1. Bhavana Acharya

      Hello sir,

      Thanks! 🙂 There still are mid-cap funds that beat this index – not as many as before but definitely not zero. It’s not the same situation as it is with large-caps today. And as pointed out, active funds are better on downsides. But yes, it is easier to invest in the index if you don’t want churn. We will cover the smallcap index at some point.

      Thanks,
      Bhavana

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