Mid-cap funds are hot with investors. What’s driving the rush and should you invest now? Here’s what fund managers say

Mid-cap mutual funds continue to attract investors even as valuations remain above their long-term averages. Fund managers say the interest is increasingly supported by earnings growth, domestic demand and the expansion of India’s formal economy, rather than simply recent market performance.

However, the optimism comes with a caveat. With valuations elevated in several pockets, investors may have less room for disappointment if earnings fail to meet expectations. Fund managers say stock selection and portfolio diversification across market capitalisations remain important.

Why are investors continuing to bet on mid-cap funds?

The sustained interest in mid-cap funds appears to be driven by more than a search for quick returns. Ankit Jain, senior fund manager at Mirae Asset Mutual Fund, said India’s evolving economic landscape is creating growth opportunities for mid-sized businesses, particularly as formalisation and digitalisation help companies gain market share and scale up.

The earnings trajectory of the segment has also supported this confidence. Jain pointed out that the Nifty Midcap 150 has delivered earnings growth of around 17% CAGR over the past nine years. The index has delivered a 16.3% CAGR return over the past 10 years.

The share of net flows going into the mid-cap category has also increased from around 14% in FY23 to almost 20% on a year-to-date basis, according to Jain.

“This points towards a more structural allocation trend,” Jain said, adding that companies gaining scale can benefit from a lower cost of capital and greater business resilience. New listings are also expanding the investable universe, he said.

Chinmay Sathe, Fund Manager – Mid-cap Fund, The Wealth Company Mutual Fund, attributed the sustained flows to strong domestic liquidity, improving investor awareness and the perception that mid-caps offer greater growth opportunities than the relatively mature large-cap segment.

He said investors are increasingly looking for companies that can compound earnings over a longer period. The flows are not necessarily momentum-driven, with several mid-cap businesses entering stronger earnings and capital-investment cycles, Sathe added.

Is the mid-cap earnings story strong enough?

Fund managers see improvement in several parts of the mid-cap universe, but they caution against treating the entire category as a single homogeneous group.

Sathe said healthy domestic demand, formalisation of the economy, infrastructure and manufacturing-led capex, along with improving balance sheets, are creating a favourable operating environment for several mid-sized companies.

However, earnings visibility varies considerably between companies. Investors need to distinguish between businesses where growth is supported by sustainable improvements in profitability and cash flows and those where market expectations have moved ahead of fundamentals, he said.

Jain similarly emphasised the importance of stock selection. He said opportunities are emerging across both domestic-facing and export-oriented businesses, but fundamentals can differ significantly across companies.

This makes the mid-cap story less about simply owning the category and more about identifying businesses that can sustain growth as they scale up.

Mid-cap valuations are above average. What should investors watch?

The biggest concern for investors is valuation. The Nifty Midcap 150 is trading at around 26 times one-year forward earnings, compared with its historical average of approximately 24.8 times, according to Jain.

That means investors are paying a modest premium to the index’s long-term average.

Jain, however, said valuations need to be considered alongside the segment’s earnings growth potential. With mid-teen earnings growth, he believes select businesses can still offer a reasonable risk-reward.

Sathe also said mid-cap valuations are not inexpensive in absolute terms. Several pockets are trading above their long-term averages, leaving less room for earnings disappointments.

“The key question at current levels is not whether mid-caps are cheap, but whether future earnings growth can justify the multiples investors are paying today,” Sathe said.

This is particularly important because a fundamentally sound company can still generate weak investment returns if its earnings do not grow quickly enough to support an elevated valuation.

Should investors shift from large caps to mid-caps?

The rise in mid-cap allocations should not necessarily be interpreted as investors abandoning large caps.

Jain said the increase in flows reflects greater recognition of the long-term growth opportunities in mid-sized companies rather than simply a switch from large caps in search of higher returns.

Sathe, however, cautioned against treating the trend as a wholesale structural shift away from large caps. Large-cap stocks continue to offer liquidity, stability and exposure to established businesses, while mid-caps provide greater growth potential but also higher volatility.

For investors, this distinction matters. A portfolio built entirely around mid-caps could face sharper drawdowns during periods of market stress.

“The sustainable approach is to diversify across market capitalisations rather than build a portfolio around chasing whichever segment has performed better recently,” Sathe said.

What is the biggest risk in mid-caps now?

Both fund managers point to the same broad risk: expectations running ahead of earnings.

Jain said elevated valuations can leave less room for disappointment. His approach is therefore focused on companies with strong competitive advantages, a track record of generating around 15% pre-tax return on capital employed and the potential to grow faster than nominal GDP. Management quality, corporate governance and execution capability are also important considerations, he said.

Jain said his team is finding opportunities across financials, insurance, pharmaceuticals and healthcare, export-oriented chemicals and manufacturing, cement and metals, as well as select new-age businesses such as consumer discretionary and logistics. Capital goods, however, appear relatively expensive to his team, making it an underweight sector.

Sathe highlighted another risk. Mid-caps can face liquidity constraints and sharper declines when markets come under stress.

For investors, the message is therefore not to avoid mid-caps because valuations are elevated, but to recognise that strong inflows do not automatically make every mid-cap attractive. The category has a credible earnings-growth story, but the price paid for that growth and the ability of individual companies to deliver on expectations will determine future returns.