Financial Markets, General, Mutual Funds, Short term programmes

When and where can you invest?

When and where can you invest?

When and where can you invest?

“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”   -Warren Buffet

Investment in the stock markets is believed to be one of the best ways to build a portfolio and a retirement fund. However, the challenge for most is the ability to identify the right companies/ stocks to invest in. It is this ability that sets apart the serial investors from the casual ones.

A small-cap company is one where the total market value of all it’s shares is less than Rs 5,000 crores.

A mid-cap company is one whose total market value is between Rs 5,000-20,000 crores.

A large-cap company is one which has a market value of over Rs 20,000 crores.

Many equity market watchers believe that now is the right time to take interest in the mid- and small-cap segments. The valuations in these segments have been become attractive in the last one-year. By attractive, these advisors mean that they expect the prices of these shares to increase to highs unseen before. The main role of financial advisors is to help decide whether an investor should invest in certain market segments or not.

The mid-cap universe of stocks comprises of stocks that are ranked from 101 to 250 based on their market capitalization. The small-cap segment consists of stocks that are ranked from 251 to 500. Mid and small-cap stocks are most likely to do well in a phase of economic recovery when interest rates are low and there are growth opportunities to exploit. Their smaller size makes them more responsive to changes and opportunities. At the same time, they are most vulnerable when there is a downturn in business cycles. Their revenues and profitability are likely to take a greater hit and, with lower financial muscle to withstand such slowdowns. They are more susceptible to market instability. In a market downturn, these stocks are likely to see a greater cut in stock prices. Mid-caps are in a good spot between large- and small-caps. They still have the flexibility of the small-cap and also have the relative stability of a more established business.

For you, the retail investor, mutual funds are the best way to invest in equity markets, including the mid- and small-cap segments. The categorization of mid-cap mutual fund schemes specifies mid-cap funds as those that invest not less than 65% of the assets in the mid-cap segment. Meanwhile, small-cap funds are those that invest not less than 65% of total assets in the small-cap segment of the market.

A look at the performance of these funds shows that in bullish markets they have outperformed the larger segments significantly. For example, in the bull market of 2014, the average return from the top five funds in the small-cap segment was 85% higher than that from the large-cap funds. Similarly, in 2017 also their returns were stated to be 45% higher than to the large-cap segment. The out performance of the mid-cap segment over large-caps in 2014 has been 56% while it was a more moderate 10% in 2017. On the flip side, in bear markets, they see a steeper fall in prices.

Over five-year and seven-year investment horizons, it has been observed that the mid- and small-cap funds have outperformed the large-cap segment in terms of returns, the higher volatility in returns, especially in the small-cap segment makes them a bit more risky. The Sharpe ratio, which measures the return generated for every unit of risk taken, was at just 0.56 for small-cap funds, and while mid-cap funds had a lower Sharpe ratio of 0.55. Large-cap funds, on the other hand, had a much higher Sharpe ratio of 0.85, indicating that the returns generated for the risk taken were much higher in large-cap funds, while small-cap and medium-cap funds are unable to generate higher returns commensurate with the risk they take.

Conclusion:

The slowing economic trends pose greater risks to this sector and it is important to be able to identify sectors and companies that can sustain in this scenario. If you are willing to ride out the volatility, you can consider some exposure to these segments through mid- and small-cap funds, but there are caveats to be followed.

A well-diversified mid and small-cap portfolio can reduce the risks faced, though the returns will be lower too. Some funds .

At BSEvarsity.com, we offer specialized courses on building wealth with mutual funds, in order to help individuals and professionals be masters at stock market investing.

 

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