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.