A reader asks, “I read your posts and blogs a lot. I try and declutter my portfolio and follow the kiss principle. If an actively managed mid-cap fund has a lower expense ratio almost equal to an index fund, provides better downside protection, and beats the benchmark index, should we still consider switching to the Nifty Next 50 (NN50) index?”
“I understand NN50 has the same profile as the Nifty Midcap150 index. Please highlight this on your blog, and I am eagerly awaiting your reply. I am talking about Kotak emerging equity versus ICICI prudential nifty next 50 index fund. I have invested in the SBI Magnum midcap fund for 2.5 years.”
Context: Our previous studies have shown considerable overlap in past Nifty Next 50 and Nifty Midcap 150 returns. Therefore, we recommend the Nifty Next 50 instead of active mid cap funds or the Nifty Midcap 150 index. See: Only four midcap mutual funds have consistently outperformed Nifty Next 50.
The Midcap index has recently significantly pulled away from the Nifty Next 50. See Nifty Midcap 150 beats Nifty Next 50 for the first time, and for updated charts, see Nifty vs Nifty Next 50 vs Nifty Midcap 150 vs Nifty Smallcap 250.
At this point in time, it is unclear if this represents a change in the risk-reward profile of the Nifty Next 50 (less volatile and possibly less rewarding) or is temporary. At present, our recommendation (at least for new investors) is:
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Use a large and midcap or flexicap fund for mid cap (and small cap exposure). There is no need for active mid cap or small cap funds. No need for passive mid cap and small cap funds. Those who appreciate the risks associated with Nifty Next 50 (often frustrating to hold) can use it as a mid cap index fund to add to their Nifty/Sensex index fund.
The reader wishes to declutter his portfolio; he already holds SBI Magnum Midcap and wants to invest in Kotak Emerging Equity, presumably as a replacement.
According to the freefincal equity mutual performance consistency screener, Kotak Emerging Equity performs better compared to Nifty Midcap 150 TRI than SBI Magnum Midcap.
1 Rolling return outperformance consistency: the fund returns are compared with category benchmark returns over every possible 3Y, 4Y, and 5Y period from 1st Jan 2013. The higher the outperformance consistency, the better. Suppose 876 fund returns were compared with 876 benchmark returns, and the fund has beaten the benchmark 675 times. The consistency score will be 675/876 ~ 0.77 or 77%. A score of 1 means 100%.
Kotak Emerging Equity Fund
- rolling return outperformance Consistency Score (3 years) 82%
- rolling return outperformance Consistency Score (4 years) 96%
- rolling return outperformance Consistency Score (5 years) 100%
SBI Magnum Midcap Fund
- rolling return outperformance Consistency Score (3 years) 55%
- rolling return outperformance Consistency Score (4 years) 45%
- rolling return outperformance Consistency Score (5 years) 38%
2 Downside performance consistency over every possible 1Y, 2Y, 3Y,4Y, and 5Y. The higher, the better. A score of 60% means 6 out of 10 times, the Fund performed better than the category benchmark when the benchmark was moving down. This is a measure of risk protection. It is computed from rolling downside capture data. Read more: An introduction to Downside and Upside Capture Ratios.
Both funds have identical and perfect downside performance consistency scores!
- downside protection consistency (3 years) 100%
- downside protection consistency (4 years) 100%
- downside protection consistency (5 years) 100%
So, it is certainly tempting to shift from SBI Magnum Midcap to Kotak Emerging Equity. The catch is such moves are subject to Murphy’s Law Risks.
Murphy’s Law of mutual fund switches states that the fund you stopped investing in will start performing better after you switch, and the fund you switched to will start performing badly.
So, as long as you know of this risk, you can switch. The bottom line is that investing in active mid cap funds, or NIfty Next 50 or midcap index funds, does not matter. What matters is, have you done a goal-based financial planning exercise? Are you investing enough for your goals in the right asset allocation and have a rebalancing and risk reduction plan in place? Where you invest is hardly as important.