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Are mid-cap funds using the right benchmark indices?

LiveMint logoLiveMint 06-03-2017 Pankaj Tibrewal

One of the most counter-intuitive trades of last 2 years has been the outperformance of Nifty Free Float Midcap 100 index relative to the Nifty benchmark, despite subdued market performance. In financial year (FY) 2017, the Nifty mid-cap index has returned 20.28% versus 9.53% by Nifty50.

In other words, when the market was sliding, Nifty 50 did so with more vigour. But when it was time to climb, it was slower than the mid-cap indices. This ‘ulti Ganga’ of Indian mid-cap indices being safer than our largest large-cap index flies in the face of everything that we hold logical and rational.

Common sense and financial management 101 has taught us that mid-cap is higher beta, that higher beta means higher risk and higher gain, and that large-caps are relatively less risky and less volatile.

Have our mid-caps grown so much in potency and fundamentals that they now outmatch the largest 50 stocks 2 years in a row? The truth is—not really. It’s the colour of the spectacles that we are wearing. The bandwagon has been beating the drum saying that even on a downside, mid-caps have outperformed large-caps.

But a finer truth is revealed under the higher lens of observation.

What if I told you that in the Nifty Free Float Midcap 100 index, nearly 64% of the stocks by weight have a market-cap of around Rs13,500 crore or more. This in other words means that around 50 of the stocks in this particular index have a market-cap weightage of around Rs13,500 crore or more. In the Indian context, these are not mid-cap stocks at all.

Vipul Sharma/Mint

Let me put it another way. There are around 24 such stocks in the mid-cap index that have a market-cap bigger than the market-cap of Tata Power, the lowest market-cap stock of Nifty 50.

In other words, around 35% of Nifty Free Float Midcap 100 index stocks by weightage are larger than the smallest market-cap stock of Nifty 50. The largest market-cap stock in the mid-cap index is Hindustan Zinc (around $20 billion), which is higher than the median market-cap of Nifty 50.

Similarly, in BSE mid-cap index also there are around 65 of 100-odd stocks that have a full float market cap of $2 billion or more. In weight terms, that nearly accounts for around 88% of the index weight.

What’s the point, some may question. Primarily, it appears that there are large-cap stocks in mid-cap clothing. And it is the performance of these camouflaged stocks that has pulled the ‘mid-cap’ indices above Nifty 50.

If we check the performance of only those stocks that have a market-cap of less than $2 billion, we will see that their performance has been much worse than that of Nifty.

So this means that it has been the ‘large-cap’ stocks in Nifty Free Float Midcap 100 index that have been beating Nifty 50.

This brings us to an important question: are we comparing with the right benchmarks? Fundamentally, is there ample consensus between what constitutes a large-cap stock and a mid-cap stock? Because in the absence of this clarity, lines get blurred and nearly every mid-cap index will have such agile elephants dancing surreptitiously with the mid-cap wolves. There is a need for clear delineation within the investment industry to point out which stock constitutes a mid-cap and which a large-cap.

In conclusion, there is need for a right and a truly reflective benchmark. In its absence, the fund management style and the outperformance as quoted by many funds may not necessarily show the true picture.

As George Bernard Shaw said: “The single biggest problem in communication is the illusion that it has taken place.”

Pankaj Tibrewal is fund manager-equity, Kotak Mahindra Asset Management Co. Ltd

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