Mid and small caps to outperform large caps, says CIO of Edelweiss MF

Growth has been on a downward trajectory for the last 4-5 years and Covid -19 accelerated it.

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Edelweiss Mutual Fund believes the stage is set for mid and small cap funds to outperform large cap funds. Harshad Patwardhan, chief investment officer (Equities) believes growth has bottomed out post outbreak of Covid 19 and it is on a upward trajectory now. While the economy shrunk by 25% in the April – June quarter, in the subsequent quarter it shrunk only by 7%, which indicates the recovery has begun and can get better.

Growth has been on a downward trajectory for the last 4-5 years and Covid -19 accelerated it. While the last two quarters were attributed to lockdowns, overall this reversal in growth is happening after 4-5 years of deceleration which happened due to a host of domestic issues like demonetization, GST related implementation issues and the IL&FS crisis. It accelerated after the onset of Covid -19. Indian economy has been decelerating for last 4 years, though growth rates are positive. In the last calendar year it saw Covid -19 when it was bottoming out and for Apr – June it bottomed out. The Indian economy subsequently shrank only by 7% so the recovery has started. Market will look ahead and things are getting better.

“Return on equity (ROE) is on a downturn from 2007-08 and it has started inching up in the last two years. If you are in beginning of growth cycle current valuations are not expensive,” says Harshad Patwardhan. This along with low interest rates could boost growth rates further. He believes mid and small caps can outperform large cap peers.

Harshad Patwardhan has been managing Edelweiss Midcap Fund since its inception in 2007. Edelweiss Midcap Fund has returned 35.32% over the last one year and is the best performing fund in the last decade returning an annualized 16.07%. Its top three holdings are Choldamandalam Investments, PI Industries and Federal bank.

The veteran fund manager believes growth from hereon will be broad based and it will benefit smaller companies in the mid and small cap space. Both the government and the RBI are focused on inducing growth and sustaining it. Given that growth is expected to come back sharply, the fund house believes condition for midcaps to outperform large caps is high based on historical evidence. Over the last 20 years, midcap indices have outperformed large cap indices in 12 years. While the Nifty 50 has grown by a CAGR of 12.8%, the NSE Nifty Midcap 100 grew by 15.6%, outperforming large cap index by 2.8% CAGR.

In the recent past in calendar years 2018 and 2019, midcap indices largely underperformed large cap indices. While large caps gained 3% and 12%, midcap lost 15% and 4%. However in 2020, the midcap index marginally outperformed the large cap index by 7%.

Whenever large cap index outperforms midcap index, the extent is less, whereas when midcap outperforms large cap the extent is high. Many midcap companies are leaders in their respective industry. Many such companies are not tracked by analysts, leaving scope for fund managers to generate high alpha.

It has been observed that large cap funds have generally struggled to outperform large cap indexes in 2018 and 2019 with very few of them managing to generate alpha. On the other hand most midcap funds have managed to generate alpha over benchmark.

The fund house believes longer the time horizon the higher the chances of you making more money in midcap funds than large cap funds. On a 3 year daily rolling return basis, 65% of times midcap index has outperformed large cap index On a 5 year daily rolling return basis, 77% of times midcap index has outperformed large cap index.


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