Last Updated on October 2, 2023 at 3:22 pm
A reader sent us a rather strongly worded email after reading the Handpicked List of Mutual Funds Oct-Dec 2023 (PlumbLine). He was unhappy that we are against investing in active mid cap and small cap fuds and wanted to know why.
Our decision stems from our monthly equity mutual fund screeners. These use rolling returns to determine how consistently a fund has outperformed a benchmark. As we recently saw – Nifty vs. Nifty Next 50 vs. Nifty Midcap 150 vs Nifty Smallcap 250 – the small cap index typically underperforms the mid cap index.
Therefore, we choose Nifty Midcap 150 TRI as a benchmark for evaluating active small cap finds and mid cap funds. Also, Why are you comparing Small Cap Mutual Funds with a Mid Cap Index?! We also use NiftyMidcap15Quality50TRI as an additional benchmark but shall not discuss the result here. You can consult our latest equity MF screener for details.
Rolling return outperformance consistency: the fund returns are compared with category benchmark returns over every possible 3Y,4Y, and 5Y period from 1 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 ~ 77%.
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Mid cap mutual funds
- There are 24 mid cap mutual funds with a five-year history. Only six have beaten the Nifty Midcap 150 TRI with 60% or more performance consistency over every possible five-year duration from Jan 2013 to Sep 2023!
- There are 25 mid cap mutual funds with a four-year history. Over four years (same rolling returns window), only seven have beaten the Nifty Midcap 150 TRI with 60% performance consistency or more.
- There are 26 mid cap mutual funds with a three-year history. Over three years (same rolling returns window), only seven have beaten the Nifty Midcap 150 TRI with 60% performance consistency or more.
Small cap mutual funds
- There are 15 small cap mutual funds with a five-year history. Only six have beaten the Nifty Midcap 150 TRI with 60% or more performance consistency over every possible five-year duration from Jan 2013 to Sep 2023!
- There are 20 small cap mutual funds with a four-year history. Over four years (same rolling returns window), only 11 have beaten the Nifty Midcap 150 TRI with 60% performance consistency or more.
- There are 21 small cap mutual funds with a three-year history. Over three years (same rolling returns window), only ten have beaten the Nifty Midcap 150 TRI with 60% performance consistency or more.
Regular readers would know that we usually demand 70% rolling return performance consistency. Even with this relaxation, the performance is quite pathetic. Today, you may hold an outperformed, but that is not a guarantee that it will stay the same in future.
This is why we cannot recommend actively managed mid cap or small cap funds in our handpicked List of Mutual Funds (PlumbLine). What about passive funds?
- Small cap index funds are a definite no-no as it has consistently underperformed the mid cap index. See Nifty vs Nifty Next 50 vs Nifty Midcap 150 vs Nifty Smallcap 250.
- A mid cap 150 index is not a terrible idea, but we are still sceptical about these as the tracking errors are significant. See: Not all index funds are the same! Beyond the top 100 stocks, tracking errors are huge! The fund manager may struggle to keep pace with the index during market downturns due to liquidity constraints.
- I would avoid factor indices based on quality, momentum, and value in these segments. For example, in 2022, NIFTY Midcap150 Quality 50 – TRI gave a minus 5.4 return. This was the 7th worst performer! Compare that with 5.45% for Nifty Midcap 150 – TRI. That is quite a gap! Investors must appreciate that the quality factor has an arbitrary definition and will be subject to poor sequences of returns from time to time.
- Considering all these, we still prefer Nifty Next 50 for those who want to look beyond Nifty 50.