MF buying – bogey of volatility

As all of you will know by now, I am not a professional financial planner, nor do I want to be. Yet, due to my blog and the Facebook group, I do get approached by a lot of people asking me for all kinds of advice, including what kind of a MF portfolio they should have. The moment I share my suggested portfolio structure with them, the first question is on whether volatility in the Mid and Small cap funds should be bought into?

The greatest myth about MF investment is that SIP is the only good way to invest. Believers of this cult are no less zealous than several religious or cultural groups that we see surfacing from time to time. The myth which follows this very closely is that of Volatility of Mid and Small cap funds and how they should be avoided at all costs. A lot of past data has been well analysed in terms of standard deviation of indices and returns to show that these funds can be volatile in comparison to diversified equity funds. I do not want to join issue with that but I have my own take on it.

Before I get into a general discussion on these funds and why I believe at least 50% of your portfolio should be having these, let me explain why I intuitively favor such funds. As the readers of the blog will know, I started with investing in stocks and built up a reasonably good portfolio, before any significant investment in MF. Though I had a fair share of large cap stocks and some of these have really done well, I realized quite soon that most of the spectacular growth stocks were in the mid and small cap segments. This is not difficult to understand from fundamentals – price of a stock is determined by demand and many of these are available at a lower price in the starting phase of their growth. Not many investors or fund managers are savvy enough or risk-taking enough to invest in these. Of course, when the companies start delivering to their potential the demand and hence the price suddenly goes up. Not all companies realize their early promise but if you are fortunate to have invested in one of the ones that do, you really have a multibagger in your hands.

With this background, when I started investing in MF, my portfolio structure had a Mid cap and a Small cap fund at all times. For more than 7 years I invested in my portfolio through SIP. Though I have realized that it was really not the best mode of investment, I have been quite satisfied with my returns in the portfolio in relative terms. Particularly in the Mid cap and Small cap fund that I invested in the XIRR has exceeded 30 %, even at current market levels. It has been one of the factors which enabled me to gain financial independence as per my plan.

Let us now look at how the Mid cap index has performed in terms of returns over the years. The Nifty Mid Cap 100 has given returns of:-

  • 2 year return is 63 % and 3 year return is 51 %
  • 3 year CAGR is 19 %
  • Performance of my Mid cap fund is in excess of 30 % XIRR

For the Small cap index the numbers were lower but even there the 3 year CAGR was 16 %.

What about Standard Deviation which is a measure of volatility? Sure, it is higher for such indices as compared to Nifty or Sensex and that is exactly the way it should be. The composition itself tends to make it more volatile as the underlying stocks are more risky than Sensex or Nifty stocks. At the same time good fund managers will be able to invest sensibly and get you fairly good returns, based on some of the winners in their portfolio. If you look at the good actively managed funds such as HDFC Mid cap opportunity or DSP BR Micro cap fund for their returns over the past 10 years then you will understand what I am talking about.

So for all of those who have stayed away from such funds based on the bogey of volatility, it is time to examine how much of growth in your portfolio this has cost you. You cannot do much about the past but there are changes you can do changes for the future. Make sure that you are having a good Mid cap and a good Small cap fund in your portfolio. In an ideal situation 50 % of your investments should be channelized here – if you feel constrained at this, start with a smaller percentage but bump it up when you see the returns over a period of time.

These are the stocks and funds that will really provide the kicker returns to your portfolio. There is no way you can afford to miss out on these – do not be swayed by doomsday predictions, chances are your financial well being will be grievously hurt if you do so.

Advertisements

3 thoughts on “MF buying – bogey of volatility

  1. Over say 10 yrs period returns of large cap and midcap funds tend to average out and both are almost at par. Is this correct ? Currently midcaps are overvalued than large cap. Is it correct ?
    Thanks.

    Like

  2. Very well thought and explained. I always liked your contra view. Though i may not approve of them 100% but it does help to see things in a new perspective.
    Awaiting Dilip query answer.
    Thanks

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s