20 midcap funds, 20 multibaggers: What makes this category a wealth creation machine?
Invesco India Midcap Fund tops the table with a 426% return, followed by Edelweiss Midcap Fund at 409% and Nippon India Growth Midcap Fund at 403%. Nine of the 20 schemes have returned more than 350%, while 11 have delivered more than 300%.
At the other end, Aditya Birla Sun Life Midcap Fund, the weakest performer in the 10-year cohort, is still up 238%. SBI Midcap Fund returned 247%, UTI Mid Cap Fund 250% and DSP Midcap Fund 255%.
ETMarkets.comA 238% absolute return over 10 years works out to roughly 13% annualised, while 426% translates into about 18%. The category average of 324% is equivalent to around 15.5% a year. The gap may not look enormous on an annual basis, but over a decade it creates a substantial difference in terminal wealth: Rs 1 lakh would have grown to roughly Rs 3.38 lakh in the weakest scheme and Rs 5.26 lakh in the strongest.
That breadth raises a bigger question: what made a category in which even the laggards more than tripled investor money so powerful?
Hemant Sood, Founder and Managing Director of Findoc Group, attributes the midcap category’s performance to three broad forces: earnings growth, valuation rerating and sustained investor flows.
Midcaps occupy an unusually fertile part of India’s corporate lifecycle. Many companies in the segment have already reached a scale that makes their businesses more resilient than smaller firms, while retaining significantly more room to grow than established largecaps.Over the past decade, Sood said, the segment benefited from formalisation of the economy, the capex and manufacturing cycle, production-linked incentive-linked sectors and operating leverage as capacity utilisation improved. But earnings were only part of the equation. Rising valuations also amplified returns, meaning investors increasingly paid more for every rupee of profit generated by midcap companies.
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Souvik Biswas, Head of Research at Bajaj Capital, sees the same structural advantage.
Midcap companies have already scaled to a reasonable size while continuing to grow, helping the segment generate strong earnings momentum. The periodic addition of fast-growing companies moving up from the smallcap universe also continuously refreshes the opportunity set.
That combination attracts investors following multiple styles, from growth and quality to momentum, value and contra strategies, helping sustain both liquidity and investor interest. Biswas said outsized returns remain plausible in the segment, primarily because of earnings growth and the liquidity and investor interest that follow it.
Manish Kothari, Co-founder and CEO of ZFunds, describes midcaps as effectively offering investors the “best of both worlds” — the operating robustness associated with large companies and the growth agility usually associated with smaller businesses.
The segment has also been expanding through both earnings growth and valuation rerating, while new-age companies entering the midcap universe are opening additional investment opportunities.
But that same success is creating the biggest question for the next decade: can midcaps repeat it?
The answer from experts is considerably more nuanced than the backward-looking return data suggests.
Sood cautions against simply extrapolating the past decade’s 15.5% annualised category return. With valuations already elevated, the rerating component that boosted historical returns may be difficult to repeat. As assets under management grow, large midcap funds could also find it progressively harder to enter and exit positions without affecting prices.
His base case is for future returns to move closer to underlying earnings growth, with wider differences emerging between the best and worst schemes. For financial planning, he considers an assumption of 10%-12% annual returns more prudent than simply projecting the historical rate forward.
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Biswas also flags valuation and volatility as the two central risks. Midcaps typically trade at richer valuations, which makes valuation risk a defining feature of the segment, while investors should also be prepared for greater volatility.
Kothari is constructive on the long-term opportunity but arrives at a similar caveat. A relatively limited universe of midcap stocks is being chased by institutions and other investors attracted by the earnings growth on offer. That demand can push valuations higher and ultimately constrain future returns.
The limited universe creates another paradox for fund managers.
Midcaps may be easier to research than smallcaps, but they can be considerably harder to differentiate in.
Sebi’s category framework requires midcap funds to maintain at least 65% exposure to midcap stocks. With the core midcap universe spanning a relatively narrow group of companies—and becoming smaller still after managers filter for governance, liquidity and valuation—multiple funds can end up competing for many of the same stocks.
That can lead to substantial portfolio overlap and make genuinely differentiated stock selection harder, particularly for funds managing large pools of capital.
Sood sums up the challenge as “easier to research, harder to differentiate”. Alpha increasingly has to come from position sizing, portfolio construction and how fund managers deploy the portion of the portfolio that is not subject to the mandatory midcap allocation.
Biswas, however, points out that the 65% requirement still affords midcap managers reasonable flexibility to invest in large caps and small caps, thereby managing the portfolio’s risk-reward profile. The real difficulty, he said, is that midcap companies are generally well known and can command higher valuations, forcing managers to continuously answer three questions: how much to pay, what growth that price is buying and how much downside risk they are accepting.
For investors, therefore, the past decade’s extraordinary scorecard carries two messages.
The first is that the midcap segment has demonstrated an unusually powerful ability to compound wealth: every one of the 20 schemes with a decade-long record has been a multibagger.
The second is that the forces responsible for those returns—earnings growth, rerating and rising flows—may not contribute equally over the next decade. With valuations elevated and an increasingly crowded investible universe, future wealth creation could depend more heavily on earnings delivery and fund manager execution than on another broad rerating of the entire category.
Midcaps may, therefore, remain a wealth creation engine, but investors should not expect the engine to run at precisely the same speed for another 10 years.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)
