Do you invest in midcap stocks or midcap funds?
Which type of midcap stocks do well?
While you want to invest in midcap stocks, you believe there is a lot of junk in midcap stocks and want to avoid such stocks.
Well, there is a strategy index in the midcap space (Nifty Midcap 150 Quality 50) that aims to do exactly that. The index fund picks quality midcap stocks from the entire midcap universe (Nifty Midcap 50).
Would a portfolio of such quality midcap stocks outperform the Nifty Midcap 150 index? And give actively managed midcap funds a run for their money?
Let’s find out.
How does Nifty 150 Quality 50 index select stocks?
The parent index is Nifty Midcap 150 index. The 50 quality stocks are selected from the universe of midcap stocks in Nifty Midcap 150 index.
How is “Quality” defined?
There is no objective definition of what constitutes a quality stock. There can be many different definitions. We will look at how NiftyIndices defines “Quality” for this index.
While selecting stocks in the Quality index, the stocks in Nifty Midcap 150 are ranked on the following parameters and top 50 stocks are chosen.
- Return on equity (Higher the better)
- Debt-to-equity (except for financial services companies) (Lower the better)
- Variability in EPF growth (Lower the better. Stable earnings are better)
The data is considered for the previous 5 years. All the parameters are given equal weightage. The index is rebalanced semi-annually.
You can read the detailed methodology here. You can also look at the current constituents here (you will not get the weight of each stock). You can check the sectoral breakup and top constituents as on the end of last month in the factsheet.
Do Quality Midcap stocks do well?
Let’s compare the performance of the Nifty Midcap 150 Quality 50 index against the parent index Nifty Midcap 150). Additionally, let’s compare the performance against a few popular actively managed midcap funds.
- Nifty Midcap 150 Quality 50 (Price index)
- Nifty Midcap 150 (price index)
- DSP Midcap Fund
- Kotak Emerging Equities
- Nippon India Growth Fund (earlier Reliance Growth Fund)
I have considered the regular plan of the 3 midcap funds for this analysis since I wanted to analyze and compare performance for a longer term. There were 5 midcap funds with AUM of over Rs 10,000 crores (that’s a good measure of popularity). Apart from the above 3, there was HDFC Midcap Opportunities and Axis Bluechip Fund. Axis Bluechip was launched in 2011 while HDFC Midcap Opportunities lost out on vintage. I wanted to pick just 3 funds to keep the charts simpler.
To avoid giving unnecessary advantage to the midcap indices, I have considered the Price index instead of Total Returns index (TRI).
We consider the data from April 3, 2007 until August 31, 2021.
Nifty Midcap 150 Quality 50: Performance Comparison
Nifty Midcap 150 Quality 30 is a clear winner. Rs 100 grows to 1,032. CAGR of 17.6% p.a.
DSP Midcap: Rs 934. CAGR of 16.8% p.a.
Kotak Emerging Equities: Rs 688. CAGR of 14.3% p.a.
Nippon India Growth: Rs 774. CAGR of 15.3% p.a.
Nifty Midcap 150: Rs 100 grows to Rs 656. CAGR of 14% p.a.
As always, point-to-point returns do not present the complete picture. Let’s look at the calendar year and rolling returns.
An interesting observation. Whenever the midcap stocks (Nifty Midcap 150) have given negative returns, Nifty Midcap 150 Quality 50 has been the best performer.
Look at the returns in the years 2008, 2011, 2013 and 2018. The only exception is 2019.
Nifty Midcap 150 Quality 50 did not have massive outperformance years, compared to other funds. However, it did not lose as much when the midcap stocks went through a bad phase. It lost less. And losing less is the key to investment success.
Nifty Midcap 150 Quality 50: Rolling Returns comparison
Again the Midcap Quality index is not setting things on fire. In fact, it has not been the best performer in 3-year rolling returns data for better part of the last 10 years. Still, it does very well.
Let’s look at the decadal returns too.
Nifty Midcap 150 Quality 50 beats the Nifty Midcap 150 index easily and consistently. And keeps up with the best performing midcap funds.
The above chart also highlights the issues with active funds. Look at how Kotak Emerging Equities struggled until 2010 and has done very well in the last decade. Exactly the opposite for Nippon India Growth Fund.
What about risk characteristics?
Nifty Midcap Quality index does well on the volatility front too. Manages drawdowns better compared to the Nifty Midcap 150 index.
Nifty Midcap 150 Quality 50 index beats Nifty Midcap 150 index easily on both risk and returns metrics.
Midcap Quality index does better or equally well compared to some of the most popular actively managed midcap funds. And it does not have any fund manager risk.
However, there are a few aspects that you must keep in mind.
- There is no index fund or ETFs based on Nifty Midcap 150 Quality 50 index at present. Hence, there is no easy way to take exposure to this passive strategy.
- The Nifty Midcap 150 Quality 50 index was launched only in October 2019. Any prior data is back-fitted. Hence, you would expect past returns to be good.
- Interestingly, the Nifty Midcap 150 Quality 50 index has underperformed Nifty Midcap 150 since its launch in October 2019.
- Past performance does not guarantee future performance.
- While the performance of the midcap quality index is impressive, it does not mean this is the best way to invest in midcap stocks. We have not tested any other strategy.
I like the concept. I believe investing in quality midcap stocks is a good way to build a portfolio of midcap stocks. Once an ETF or index fund around Nifty 150 Quality 150 index is launched, I will consider taking exposure as part of the satellite equity portfolio.