'Small and mid cap mutual funds are attractive bets, but beware of volatility'

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The outlook for mid and small cap funds is positive but volatile, says a new research note by Edelweiss Mutual Fund. After a long underperformance in 2018 and 2019, mid and small cap are seeing a reversal. The note says that over an investment horizon of 3-5 years, returns from small and mid cap funds can be very attractive.

The recovery has surprised the market positively, the Government is actively encouraging revival and benign monetary conditions are likely to continue. Due to this, FPI flows are robust. The fund house sees this as a very positive environment for small and mid cap stocks.

The note also highlights that over longer periods mid and small caps have outperformed large caps. Historically, NSE Midcap100 Index has delivered positive returns in 14out of 20 years, with a CAGR of 15.6%. On a 3-year daily rolling return basis, 64% of times midcap index has outperformed large cap index. On a 5-year daily rolling return basis, 76% of times the midcap index has outperformed the large cap index. On a 5-year daily rolling return basis, 76% of times midcap index has outperformed large cap index. Mid and small caps outperformed large caps in 12/20 years, data from Bloomberg suggests.

The fund managers at Edelweiss Mutual Fund believe that there will be higher degree of volatility in small and mid cap segments compared to last 12-15 months and possible corrections from time to time.

“Don’t confuse volatility for risk. Higher volatility is a friend of long-term patient investors. Spreading out investment over a period looks prudent at this stage. Expect midcap/small cap outperformance to continue due to broad-based recovery. However, note that we have travelled some distance on this road already,” Harshad Patwardhan, Chief Investment Officer – Equities at Edelweiss Asset Management.

The fund house says that investors should also remain cautious of the potential risks in the segment. Subsequent infection waves derailing economic recovery can be a risk for small and mid cap funds. Global central banks reversing benign monetary policy due to inflation can impact the returns from these funds.

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