Small and midcap funds category has outperformed large cap and diversified equity funds categories in the last one year (please refer to our article Small and Midcap funds are now outperforming large cap funds). Small and Midcap funds, though inherently risky, have the potential of giving superior returns compared to large cap and diversified equity funds. Large cap funds and midcap funds outperform each other in different time periods. Therefore, small & midcap funds should form a part of your mutual funds portfolio, so that you can benefit over different stages of your investment horizon. There is a lot of misconception regarding small and midcap companies in our country. Investors fear that small and midcap companies do not have high standards of corporate governance, and as result are not fundamentally good investments. However, in reality, many midcap companies have excellent management teams and very high standards of corporate governance. These midcap companies, over time, become large cap companies and give their investors excellent returns on their investments. Small and midcap funds are excellent instruments, through which you can invest in high quality small and midcap companies. In this article, we will review some top performing small and midcap funds, based on CRISIL's most recent mutual fund rankings, for the quarter ended March 31 2014, that investors may consider.
All the funds in our selection have excellent returns over the last one year. As with all mutual fund investments, recent performance may not always be sustained in the future. One needs to look at a number of parameters to compare and rank schemes, relative to their peer group. CRISIL ranks equity funds based on several parameters like average 3 year annualized returns, volatility, portfolio concentration risk (both industry and company) and portfolio liquidity risk. On each of these parameters, each scheme is accorded a cluster rank (from 1 to 5) relative to its peer group. To derive a composite cluster rank, CRISIL has assigned different weights to each parameter, with average 3 year annualized return given the highest weights at 50%, volatility 30%, industry concentration risk 10%, company concentration risk 5% and liquidity risk 5%. The period of analysis is broken into four periods, latest 36, 27, 18 and 9 months. Each period is assigned a progressive weight starting from the longest period as follows: 32.5%, 27.5%, 22.5% and 17.5% respectively. For our selection, we have chosen 7 small and midcap funds that have been ranked either 1 (Very Good Performers) or 2 (Good Performers), by CRISIL.
Franklin India Smaller Companies Fund (CRISIL Rank 1):
This fund has given the highest 3 year annualized return at 25.1%. The last one year performance has also been particularly strong. The trailing one year return of the fund (growth option) is nearly 66%. Volatility of returns is low relative to the category of small and midcap funds. The annualized standard deviation of returns of monthly returns is 19.7% versus 21% for the category. Its portfolio is sufficiently diversified, with a growth orientation. The top 5 stock holdings, Finolex Cables, Yes Bank, JK Lakshmi Cement Ltd, Amara Raja Batteries Ltd, and KEC International Ltd account for less than 17% of the portfolio holdings. The fund is reasonably well diversified across sectors with a bias to cyclical sectors. The top 5 sectors, Engineering, BFSI, Chemicals, Services and Construction account for about 68% of the portfolio value.Mirae Asset Management Emerging Bluechip Fund (CRISIL Rank 1):
The scheme's 3 year annualized return stands at 23.3%, while the 1 year returns stand at 64.3%. Volatility of returns, as measured by annualized standard deviation of monthly returns, is quite low compared to peers, at 18.2%. In terms of portfolio composition, the fund has a growth focus. The fund is well diversified from the point of view of company concentration with its top 5 holdings, ICICI Bank Ltd, Sundaram Finance Ltd, Federal Bank Ltd, Tech Mahindra Ltd and Motherson Sumi Systems Ltd accounting for only 18%. In terms of industry concentration, the fund has a bias for cyclical sectors. The top 5 sectors, BFSI, Services, Pharmaceuticals, Engineering and Oil & Gas comprise of nearly 62% of portfolio value.SBI Magnum Midcap Fund (CRISIL Rank 1):
The 3 year annualized return of this fund is 22.5%, while the 1 year returns stand at 59.1%. Volatility of returns, as measured by annualized standard deviation of monthly returns, is quite low compared to peers. The 3 year annualized standard deviation of monthly returns of fund is 18.8%. The fund portfolio has a high growth bias. The fund is well diversified from the point of view of company concentration with its top 5 holdings, Motherson Sumi Systems Ltd, Page Industries Ltd, Federal Bank Ltd, Ramco Cements Ltd and Britannia Industries Ltd accounting for only 18% of the portfolio value. In terms of sector allocation the portfolio has a bias for cyclical sectors. Sectors like BFSI, Engineering, Automobile, Construction, Metals, Consumer Durable and Metals comprise 44% of the portfolio holdings. However, the portfolio also has significant allocations to defensive sectors. FMCG, Pharmaceuticals and IT comprise over 22% of the portfolio value.JP Morgan India Smaller Companies Fund (CRISIL Rank 2):
The annualized 3 year return is 21.9%. The one year trailing annualized return is 62%. Volatility of returns, measured in terms of annualized standard deviation of monthly returns, at 20.5% is in line with the volatility of the small and midcap funds category. The portfolio is fairly well diversified, with the top 5 holdings, Motherson Sumi Systems Ltd, Adani Ports & Special Economic Zone Ltd, Power Finance Corp Ltd, Bharat Forge Ltd and Shree Cements Ltd, accounting for 28% of the portfolio. In terms of industry exposure, the portfolio has a heavy bias for cyclical sectors. The top 5 sectors, BFSI, Engineering, Construction, Automobiles and Services account for over 83% of the portfolio holdings.Principal Emerging Bluechip Fund (CRISIL Rank 2):
The annualized 3 year return is 21.1%. The fund has given a return of 55.5% in the last 1 year period. The volatility of returns, measured in terms of annualized standard deviation of monthly returns, is in line with that of the small and midcap funds category, at 20.4%. The portfolio is fairly well diversified across mid cap companies, with the top 5 holdings Federal Bank Ltd, Amara Raja Batteries Ltd, Tech Mahindra Ltd, Sadbhav Engineering Ltd and Motherson Sumi Systems Ltd accounting for only 17% of the portfolio value. This fund also has a bias for cyclical sectors. However, in terms of industry exposure the fund is well diversified with the top 5 sectors, BFSI, Construction, Pharmaceuticals, Engineering and Automobiles accounting for less than 63% of the portfolio.Reliance Small Cap fund (CRISIL Rank 2):
The annualized 3 year return is 24.3%. The fund has provided the highest trailing return in the last one year period among all small and midcap funds. The last 1 year trailing return stands at almost 96%. Volatility of returns, measured in terms of annualized standard deviation of monthly returns, is a little on the higher side at 22.1%. However, in terms of risk adjusted returns, the performance is very strong indeed. The portfolio has a value focus. In terms of company concentration, the fund is fairly well diversified, with the top 5 companies Atul Ltd, LG Balakrishnan & Brothers Ltd, Ceat Ltd, TVS Motor Co Ltd and Persistent Systems Ltd account for less than 22% of the portfolio. In terms of industry concentration, the portfolio has a bias for cyclical sectors. The top 5 sectors, Chemicals, Construction, Engineering, BFSI and FMCG, account for nearly 59% of the portfolio.SBI Magnum Global fund (CRISIL Rank 2):
The annualized 3 year return is 19.6%. The last one year trailing return is 44.67%. The volatility of returns, measured in terms of annualized standard deviation of monthly returns, is much lower compared to the small and midcap funds category, at only 15.4% as compared to the category standard deviation of nearly 21%. The portfolio is fairly well diversified across small and midcap companies, with the top 5 holdings Shriram City Union Finance Ltd, Page Industries Ltd, Procter & Gamble Hygiene and Health Care Ltd, Fag Bearings India Ltd and Kennametal India Ltd accounting for less than 20% of the portfolio value. Though the fund has a bias for cyclical sectors (more than 75% portfolio weight), it has significant allocations to defensive sectors as well (nearly 25% portfolio weight). The top 5 sectors, Engineering, BFSI, FMCG, Services and Automobiles account for nearly 70% of the portfolio holdings.
Conclusion
In this article, we have reviewed the top small and midcap funds for investment in 2014. Midcap funds are more volatile than diversified equity funds. Therefore investors in small and midcap funds should ensure that these funds are aligned with their risk tolerance and investment horizon in their financial plan. Investors should consult with their Prajna Capital, if these funds are suitable options for their investment portfolio.
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