Midcap mutual funds struggle to beat this factor-based midcap index

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A factor-based index is one in which parameters like volatility, momentum, alpha, ROE, PB, PE etc are used to construct the index instead of market capitalization. This is one way to reduce concentration risk in traditional indices like Nifty and Sensex. Midcap mutual funds have struggled to beat the NIFTY Midcap150 Quality 50 Index.

While the NIfty 100 consists of the top 100 companies based on full market capitalisation from NIFTY 500, the Nifty Midcap 150 Index represents the next 150 companies (companies ranked 101-250) based on full market capitalisation from NIFTY 500.

The NIFTY Midcap150 Quality 50 index chooses 50 companies from the Nifty Midcap 150 index based on a “quality score”. The score represents higher profitability, lower leverage and more stable earnings from the Nifty Midcap 150 universe.

Regular readers may be aware that we have discussed different types of these indices before:(1)  How good are the top 10 stocks of NIFTY Quality Low-Volatility 30 Index? (2) Are Nifty Smart Beta (strategic) Indices better than the Nifty Next 50? (3) Watch my talk on momentum and low volatility stock investing in India

According to the methodology document, equal weight is given to return on equity (last fiscal year), debt to equity (last fiscal year) and last five year EPS growth variability. The debt to equity factor is not used for financial services stocks.

A quality score is defined as 0.33 * Z score of ROE + 0.33 * – (Z score of D/E) + 0.33* – (Z score of EPS growth variability). Here Z scores refer to how much a particular factor deviates from average value divided by the standard deviation.

The index is weighted by the square root of the free float market cap times the quality score. Each stock can either have a maximum exposure of 5% or five times its weight in the parent index.

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The Quality index is compared below since inception and 1st Feb 2018 with Nifty MIdcap 150.

NIfty MIdcap 150 TRI vs NIfty MIdcap Quality 150 TRI since inception
NIfty MIdcap 150 TRI vs NIfty MIdcap Quality 150 TRI since inception
NIfty MIdcap 150 TRI vs NIfty MIdcap Quality 150 TRI since 1st Feb 2018
NIfty MIdcap 150 TRI vs NIfty MIdcap Quality 150 TRI since 1st Feb 2018

Shown below are the rolling returns and rolling standard deviation over five years (left panel) and three years (right panel). Even during periods when the quality index did not outperform the parent index, it has been less volatile (lower the standard deviation, lower the volatility).

Rolling returns over 3 and 5 years for Nifty Midcap 150 and Nifty Midcap Quality 150 TRI
Rolling returns over 3 and 5 years for Nifty Midcap 150 and Nifty Midcap Quality 150 TRI

The quality midcap index has also fared well against NIfty Next 50 TRI.

Rolling returns over 5 years for Nifty Next 50 TRI vs Nifty Midcap 150 vs Nifty Midcap Quality 150 TRI
Rolling returns over 3 and 5 years for Nifty Next 50 TRI vs Nifty Midcap 150 vs Nifty Midcap Quality 150 TRI

The table below shows how poorly midcap funds have performed when compared to the NIFTY Midcap150 Quality 50 index over five years and three years.

FundNo of rolling return entries (5 Years)No of times fund has outperformed the index (5 years)rolling return outperformance Consistency Score (5 years)
Kotak Emerging Equity Scheme – Growth – Direct62349980%
L&T Mid Cap Fund-Direct Plan-Growth62443670%
DSP  Midcap Fund – Direct Plan-Growth62428145%
Invesco India Midcap Fund – Direct Plan-Growth Option62425240%
UTI Mid Cap Fund-Growth Option- Direct62519231%
HDFC Mid Cap Opportunities Fund -Direct Plan-Growth Option62519131%
Axis Midcap Fund – Direct Plan-Growth62417328%
Franklin India Prima Fund – Direct-Growth62513722%
Sundaram Mid Cap Fund- Direct Plan-Growth Option6246210%
SBI Magnum MIDCAP FUND – DIRECT PLAN – GROWTH624163%
Motilal Oswal Midcap 30 Fund (MOF30)-Direct Plan-Growth Option33882%
Tata Mid Cap Growth Fund – Direct Plan-Growth62451%
Taurus Discovery (Midcap) Fund-Direct Plan-Growth Option62500%
Aditya Birla Sun Life Midcap Fund – Growth – Direct Plan62400%
BNP Paribas Mid Cap Fund – Direct Plan-Growth Option62400%
Reliance Growth Fund – Direct Plan-Growth Plan – Growth Option62400%
Baroda Mid-cap Fund- Plan B (Direct) – Growth Option61900%
Quant Mid Cap Fund-Growth Option-Direct Plan61900%
DHFL Pramerica Midcap Opportunities Fund – Direct Plan-Growth Option39500%
FundNo of rolling return entries  (3 Years)No of times fund has outperformed the index (3 years)rolling return outperformance Consistency Score (3 years)
L&T Mid Cap Fund-Direct Plan-Growth111465259%
Kotak Emerging Equity Scheme – Growth – Direct111348644%
Sundaram Mid Cap Fund- Direct Plan – Growth Option111447843%
BNP Paribas Mid Cap Fund – Direct Plan – Growth Option111446642%
HDFC Mid Cap Opportunities Fund -Direct Plan – Growth Option111546141%
Franklin India Prima Fund – Direct – Growth111545341%
SBI Magnum MIDCAP FUND – DIRECT PLAN – GROWTH111443939%
DSP  Midcap Fund – Direct Plan – Growth111443439%
Invesco India Midcap Fund – Direct Plan – Growth Option111442238%
Tata Mid Cap Growth Fund – Direct Plan Growth111440636%
UTI Mid Cap Fund-Growth Option- Direct111538034%
Aditya Birla Sun Life Midcap Fund – Growth – Direct Plan111437233%
Axis Midcap Fund – Direct Plan – Growth111434331%
Motilal Oswal Midcap 30 Fund (MOF30)-Direct Plan-Growth Option82816119%
Taurus Discovery (Midcap) Fund-Direct Plan-Growth Option111511210%
Reliance Growth Fund – Direct Plan Growth Plan – Growth Option111400%
Baroda Mid-cap Fund- Plan B (Direct) – Growth Option110900%
Quant Mid Cap Fund-Growth Option-Direct Plan110800%
DHFL Pramerica Midcap Opportunities Fund – Direct Plan – Growth Option88500%
BOI AXA MID & SMALL CAP EQUITY & DEBT FUND – DIRECT PLAN GROWTH23900%
Edelweiss Mid Cap Fund – Direct Plan – Growth Option15800%
IDBI Midcap Fund Growth Direct11100%
Mahindra Unnati Emerging Business Yojana – Direct Plan – Growth000%

What does this mean? While the manner in which the short-list was created is debatable, with a short trade-history (shorter than back-projected data), it is certainly food for thought that a simple automated short-list of midcap stocks has been tough for active fund managers to beat. Although data Mining in Index Construction is an issue, as it stands the NIFTY Midcap150 Quality 50 index is a good candidate for a passive mutual fund.

With only three midcap mutual funds managing to beat Nifty Next 50 consistently and only six midcap mutual funds overpowering Nifty Midcap 150 in the last 5 years, it is time for investors to question if active midcap funds are necessary for their portfolios.

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About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com


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