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A Complete Guide to Mid Cap Mutual Funds

mid cap funds
mid cap funds
mid cap funds

Introduction

Midcap mutual funds primarily invest in midcap companies. They have the potential to give high returns during market ups. However, they have downside risk, as well. Mid cap funds in India have the potential to give substantial returns in the long term. These funds provide a good opportunity for wealth creation with an investment amount as low as INR 500. Also, these funds are highly liquid and managed by professionals. Investors with an investment horizon of minimum 7-10 years can look at investing in these funds.

What are mid cap mutual funds?

Mid cap mutual funds in India are a type of equity mutual funds. They are mandated to invest at least 65% of their assets in mid cap stocks. Mid cap stocks or mid cap companies are those companies that rank 101st to 250th in terms of market capitalization. Mid cap companies have the potential to grow into large cap companies. But there are two sides to a coin. A midcap company is emerging to become an established company. However, there can be chances of a downfall.

Midcap mutual funds try to strike a balance between risk and return. These funds have higher growth potential than large cap funds at the same time are less riskier than small cap funds. Mid cap mutual funds primarily invest in midcap companies. Some of these companies cater to emerging markets are often undervalued, under-researched and hence undervalued. The portfolio managers of the fund house need to perform extensive research to find potential stocks for the mid cap fund portfolio.

They are highly sensitive to market conditions. They have the potential to give high returns in good market conditions. However, adverse market conditions can drag the mutual fund scheme returns down. Hence to protect themselves from these conditions, investors are suggested to stay invested for long horizons in these funds. This will help investors overcome the effect of market fluctuations on their investments.

Mid cap mutual funds are taxed like any other equity fund.

The short term capital gains (gains within one year of investment) are taxed at 15%. The long term capital gains are taxed at 10%. Also, the long term capital gains are taxed only if the gains in a financial year are above INR 1,00,000. Moreover, dividends from mid cap equity mutual funds are also taxed. Dividends are taxed and to be paid by investors at their income tax slab rate. Dividends above INR 5,000 are subject to TDS.

Advantages of investing in midcap funds

Mid cap equity mutual funds have good potential to generate significant returns in the long term. Though they have a certain amount of risk associated with them, investing in midcap funds has the following advantages:

  • Wealth creation: A midcap company has good growth potential. In other words, these companies are less known and have good potential to generate significant returns. Therefore investors looking to create wealth in the long term can consider investing in mid cap mutual funds.
  • Diversification: They help investors in diversifying their investment portfolio. The investment is spread across various mid cap stocks and sectors.
  • Liquidity: Mid cap mutual funds are open ended equity funds. Investments in these funds can be easily liquidated. One can buy and sell the units of a mid cap mutual fund scheme at the prevailing net asset value (NAV). The fund house releases NAV data every day. They do not have any lock-in period. Hence these are highly liquid investments.
  • Professional Management: These are professionally managed by a qualified and experienced fund manager. The expertise of the fund manager reflects on the performance of the fund. The fund manager and the team make investment decisions based on thorough research.
  • Low investment amount: They do not require large investment amounts. Investing can be done either through SIP or lump sum route. Therefore, investors can start investing in mid cap funds with as low as INR 500. Also, investors can easily realize their financial goals in the long term by starting with small investments in top performing mid cap funds.

Limitations of mid cap funds

Following are the limitations:

  • Risk: Mid cap mutual funds are a type of equity mutual funds. These are market linked instruments and hence are subject to volatility. Only investors willing to take the risk associated with mid cap mutual funds can invest. They have good potential to earn significant returns in a favourable market scenario. However, the same fund can fumble in a non favourable scenario.
  • Costs: Similar to other types of mutual funds, mid cap funds also charge a fee from their investors. The fee is known as the expense ratio. With the changing market scenarios, the fund manager is required to alter the portfolio allocation. As a result, these funds might have a higher turnover ratio and costs.

Who should invest in mid cap funds?

Mid cap funds are a category of equity mutual funds that invest in midcap stocks. Mid cap stocks are of companies ranking between 101th and 250th by market capitalization. As these are pure equity funds, investors who are willing to take the risk associated with them can invest in midcap funds.

Mid cap companies can generate significant returns in the long term. These companies are also highly volatile. Additionally, mid cap companies have good growth potential.

One can invest in top performing mid cap funds to achieve their long term financial goals. Also, investors who are not affected by short term volatility can invest in mid cap mutual funds. They are good for portfolio diversification as the companies have good growth potential. Therefore, investors looking to accumulate wealth in the long term can invest in midcap funds. However, these funds have a significant amount of risk associated with them.

Things to consider before investing

Before investing in them, the investor has to consider the following:

Mutual Fund Performance

The performance of any investment has to be considered before one decides to invest. Investors have to assess the historical performance of mid cap funds. They have to assess how the fund is performing over the last 5-7 years. Compare the fund’s performance with the category of mid cap funds. Compare the performance with the benchmark. Investors can choose mid cap mutual funds to invest, only if the funds are performing ahead or at par with the category and the benchmark.

Expense Ratio

It is important to consider the expense ratio of the fund while investing in a mutual fund. SEBI has capped the expense ratio for mutual funds based on the type and category. However, investors have to pick funds with the least expense ratio.

Taxation

Taxation for mutual funds is important. This is because investors invest to earn returns and the returns are taxable. Investment in mid cap funds doesn’t qualify for tax exemption under Section 80C of the Income tax Act. The returns from mid cap funds are also taxable. The short term capital gains (gains within one year of investment) are subject to 15% tax. The long term capital gains are subject to 10% tax. Also, the long term capital gains are subject to tax only if the gains in a financial year are above INR 1,00,000.

Moreover, dividends from mid cap mutual funds are also subject to tax. Dividends are taxed and to be paid by investors at their income tax slab rate. Dividends above INR 5,000 are subject to TDS.

In the current scenario, the dividend option might not seem attractive due to the dividend tax. Hence investors have to carefully consider which option to choose (dividend fund or growth fund option) and when to redeem (short term or long term).

Financial goals

Financial goals play an important role in choosing mid cap funds. Mid cap mutual funds best suit long term financial goals like a child’s education or marriage or building a house (after ten years). For short term financial goals like getting a car or going on a vacation, mid cap funds aren’t suitable.

Investment horizon

The investment horizon of an investor is very important for choosing a mid cap mutual fund. Investors have to stay invested for at least 7-10 years to maximize benefits from these funds. In the short term, mid cap funds are subject to market fluctuations and may negatively affect the portfolio returns.

Age

The age of an investor should be considered before investing in mid cap funds. Young investors will have long investment horizons and low financial responsibilities. Hence they will have a higher ability to take risk than investors who are nearing retirement. Therefore, investors have to consider their age before investing in these funds.

Understanding of risk

Investors might have the ability to take risks. However, they might not be willing to take the risk. Investors, before investing in mid cap funds, need to understand the risk of investing in these. These are sensitive to market conditions, and they might have the potential to earn returns but at the same time can have downside risk. Investors who worry for small short term market movements should consider investing in diversified investments. However, investors who can stay invested in mid cap funds for the long term despite market fluctuations can earn substantial returns.

Published on August 20, 2020