Are Small and Mid-Cap Mutual Funds Good for Investment?

Actual Question:

Should I continue investing in Franklin smaller companies and an L&T midcap fund? How are these 2 funds for long-term investment?

I am 22 years old and currently I am investing in these funds through SIP ₹4000 each. And by long term I mean 10–15 years. Also if you can suggest some more funds to add in my portfolio since I can spare an additional ₹3000 SIP.

Answer:

Dear Friend!

I am sorry, I should point out two discrepancies in your present investment strategy:

Investing in small-cap and mid-cap companies.

It seems that you are investing in costly, actively managed mutual funds.

Small and Mid-Cap companies:

One should always invest in companies that are large. Why?

1. In the first place, Large companies have become to that stature because they have some inherent strengths/ advantages.
2. They can attract financial resources, when required, at competitive rates to implement major expansions, technological up-gradations, etc.
3. They have the resilience to recover from major mistake in case they happen to make a few.
4. At times of a market meltdown large and mid sized comapnies bear the maximum brunt. Large companies though affected escape with just bruises.

 In my case, when investing in shares directly, I make sure that the company has a minimum turnover of Rs.10000 crores (US$ 1.5 billion) and a market capitalisation of an equal amount. These companies will typically fall under the mid-cap segment, but are a select few with extremely good fundamentals. But mutual funds’ inclusion criteria are more biased towards considerations like price momentum, sectoral prospects, etc., rather than company fundamentals.

Costly, Actively Managed Funds:

Actively managed funds are funds that undergo frequent changes by buying new stocks and selling existing ones, with an purported aim of maximising returns. However history proves otherwise. The fund management fee charged for active funds ranges between 3–4% per annum. You can imagine the total fees charged by the fund over an investing period of 15 to 20 years!

Investor in mutual funds will benefit by investing in well diversified, low cost index mutual funds or exchange traded funds. The fund management fees for such passive funds are below 0.5% per annum.

Your Particular Situation:

Finally coming to your personal investment situation, I suggest that you stop your existing SIPs and start a SIP of:

• SBI ETF (Exchange Traded Funds) BSE 100
• LIC MF ETF - Nifty 100
• ICICI Prudential CNX 100 iWIN ETF

Please note that I have not recommended the above based on any returns or performance but simply because:

• They are low cost, exchange traded funds.
• The fund are operated by large financial institutions that you can expect to be in business for the next 100 years
• They are composed of the Top 100 Indian companies.

Suggested Further Reading:

• Types of Mutual Funds
• How to Choose the Right Mutual Fund to Invest?
• What is an Exchange Traded Fund?

Thank you,

With Best Regards

Anand

Index Funds of Top 10 Mutual Funds

Meaning:

Index Funds are passive mutual funds that track a popular stock index. Diversified index funds are recommended for investors who cannot afford to learn and invest on their own.

They are called passive because the fund manager need not actively manage the fund by way of frequent purchase and sale of stocks. Stock indices do not undergo frequent changes. Index funds that track popular indices, once constituted by buying shares of that constitute the index in exact proportion, does not require any change unless there is a change in the composition of the index, which is a relatively infrequent event.

Diversity contributes safety based on the principle that when we have a large basket of stocks (about 500 stocks) 80% perform average, 10% perform brilliantly and another 10% will prove to be total duds; overall such diversified portfolio will give reasonable safety.

Example:

We present here a list of index funds offered by ‘The Top Ten Mutual Funds of India’ ranked by the assets under management:

Name of Fund	Index Fund Available?		Name of Index	Number of Stocks	Diversified?
ICICI Prudential Mutual Fund	YES	ICICI Prudential Nifty Next 50 Index Fund	CNX S&P Nifty	50	POOR
HDFC Mutual Fund	YES	HDFC TOP 200 FUND	BSE 200	200	REASONABLE
Reliance Mutual Fund	YES	RELIANCE TOP 200 FUND	BSE 200	200	REASONABLE
Birla Sun Life Mutual Fund	YES	BSL Top 100 Fund	TOP 100 By Market Capitalisation	100	SPARCE
SBI Mutual Fund	YES	SBI NIFTY INDEX FUND	CNX S&P Nifty	50	POOR
UTI Mutual Fund	YES	UTI - Nifty Index Fund	CNX S&P Nifty	50	POOR
Franklin Templeton Mutual Fund	YES	Franklin India Index Fund - NSE Nifty Plan	CNX S&P Nifty	50	POOR
Kotak Mahindra Mutual Fund	YES	Kotak Sensex ETF Fund	S&P BSE Sensex	30	POOR
IDFC Mutual Fund	YES	IDFC Nifty Fund	CNX S&P Nifty	50	POOR
DSP BlackRock Mutual Fund	YES	Top 100 Equity Fund	S&P BSE 100	100	SPARCE
This list is not exhaustive. Funds may have other index schemes that may be more diversified.

Conclusion:

Even though the Bombay Stock Exchange has a well diversified, ‘S&P BSE 500 Index’, we are unable to locate an index funds tracking this index. Perhaps the reason is to cater to customer perception that top index companies are safer and will provide better returns. However, in reality it is a only a fund that tracks a well diversified index that ensures safety and growth.