If you are looking for a way to invest in the Indian stock market and diversify your portfolio, you might have come across the term mid cap index fund. But what exactly is a mid-cap index fund and how can it benefit you as an investor? In this blog post, we will explain what a mid-cap index fund is, how it works, what are its advantages and disadvantages, and which mid cap index funds are the best ones to invest in India.
What is a mid-cap index fund?
A mid cap index fund is a type of mutual fund that invests in the stocks of mid-sized companies that are listed on a specific index. In India, the most popular mid cap index is the Nifty Midcap 150 Index, which consists of 150 companies that rank from 101st to 250th in terms of market capitalization on the National Stock Exchange (NSE). A mid cap index fund aims to replicate the performance of this index by buying and holding all or most of the stocks in the same proportion as the index.
How does a mid-cap index fund work?
A mid cap index fund works by passively tracking the Nifty Midcap 150 Index. This means that the portfolio management services does not actively select or manage the stocks in the portfolio, but simply follows the composition and weightage of the index. The fund manager also periodically rebalances the portfolio to reflect any changes in the index, such as addition or deletion of stocks, corporate actions, etc. By doing so, the fund tries to minimize the tracking error, which is the difference between the returns of the fund and the index.
What are the advantages and disadvantages of a mid-cap index fund?
The main advantages of investing in a mid-cap index fund are:
- Diversification: A mid cap index fund offers exposure to a diversified basket of 150 mid-sized companies across various sectors and industries. This reduces the risk of concentration and volatility compared to investing in individual stocks or sector-specific funds.
- Growth potential: Mid cap companies are typically at a stage where they have established themselves in their respective domains and have a potential to grow faster than large cap or small cap companies. They can also benefit from favorable economic conditions, policy reforms, innovation, etc. A mid cap index fund can capture this growth potential and offer higher returns over the long term.
- Low cost: A mid cap index fund has a low expense ratio compared to actively managed funds, as it does not incur high costs for research, analysis, stock selection, etc. The lower cost translates into higher returns for investors over time.
- Transparency: A mid cap index fund has a transparent portfolio that reflects the composition of the underlying index. Investors can easily access and monitor the holdings and performance of the fund at any time.
The main disadvantages of investing in a mid-cap index fund are:
- Higher risk: A mid cap index fund carries a higher risk than large cap or diversified equity funds, as mid cap companies are more vulnerable to market fluctuations, competition, regulatory changes, etc. They can also face challenges in scaling up their operations, managing cash flows, maintaining quality standards, etc. A mid cap index fund can experience higher volatility and lower liquidity than large cap funds.
- Lower dividend yield: A mid cap index fund typically has a lower dividend yield than large cap or value-oriented funds, as mid cap companies tend to reinvest their profits for growth rather than distribute them as dividends. Investors looking for regular income may not find a mid-cap index fund suitable for their needs.
- Tracking error: A mid cap index fund may not be able to exactly replicate the performance of the Nifty Midcap 150 Index due to various factors such as transaction costs, cash holdings, portfolio rebalancing, etc. This can result in a tracking error that can affect the returns of the fund.
Which mid cap index funds should I choose to invest in India?
There are currently six mid cap index funds available in India that track the Nifty Midcap 150 Index. They are:
- Motilal Oswal Nifty Midcap 150 Index Fund
- Nippon India Nifty Midcap 150 Index Fund
- Navi Nifty Midcap 150 Index Fund
- Aditya Birla Sun Life Nifty Midcap 150 Index Fund
- ICICI Prudential Nifty Midcap 150 Index Fund
- SBI Nifty Midcap 150 Index Fund
The performance and characteristics of these funds are discussed below.
What is Nifty Midcap 150 Index?
Nifty Midcap 150 Index is a benchmark index that represents the performance of the next 150 companies (companies ranked 101-250) based on full market capitalisation from NIFTY 500. This index intends to measure the performance of mid-market capitalisation companies. As of March 29, 2019, the NIFTY Midcap 150 Index represented about 12.9% of the free float market capitalization of the stocks listed on NSE and had a total traded value of approximately 19.3% of the traded value of all stocks on NSE.
Why invest in Nifty Midcap 150 Index Funds?
Nifty Midcap 150 Index Funds are a type of passive funds that aim to replicate the performance of the Nifty Midcap 150 Index by investing in the same stocks and in the same proportion as the index.
These funds offer several benefits to investors, such as:
- Diversification: By investing in a basket of 150 mid-cap stocks across various sectors and industries, these funds offer exposure to a diversified portfolio that can reduce the risk and volatility associated with individual stocks.
- Low cost: Since these funds do not require active management or research, they have lower expense ratios than actively managed funds. This can enhance the returns for investors over the long term.
- Transparency: These funds disclose their portfolio holdings on a daily basis and follow a predefined investment strategy that does not change with market conditions. This makes them transparent and easy to understand for investors.
- Tax efficiency: These funds are treated as equity funds for tax purposes and enjoy favourable tax treatment. The long-term capital gains (LTCG) from these funds are taxed at 10% (plus surcharge and cess) if they exceed Rs.1 lakh in a financial year. The short-term capital gains (STCG) are taxed at 15% (plus surcharge and cess).
How to choose the best Nifty Midcap 150 Index Fund?
Nifty Midcap 150 Index is a market capitalization weighted index that represents the performance of the mid-sized companies in India. It consists of 150 stocks that rank between 101 and 250 in terms of full market capitalization. Investing in Nifty Midcap 150 Index Funds can help investors diversify their portfolio and capture the growth potential of the midcap segment.
However, not all Nifty Midcap 150 Index Funds are created equal. While all the six Nifty Midcap 150 Index Funds follow the same index, they may differ in terms of their performance, tracking error, expense ratio, fund size, liquidity, and exit load. Therefore, investors should compare these factors before choosing the best fund for their portfolio.
Some of the key parameters to consider are:
- Performance: Investors should compare the historical returns of these funds with the benchmark index and other similar funds over different time periods. They should also look at the risk-adjusted returns, such as Sharpe ratio and Sortino ratio, which measure how much excess return a fund has generated per unit of risk taken.
- Tracking error: Tracking error is a measure of how closely a fund follows its benchmark index. It is calculated as the standard deviation of the difference between the fund’s returns and the index’s returns over a given period. A lower tracking error indicates a higher degree of accuracy and consistency in replicating the index.
- Expense ratio: Expense ratio is a measure of how much a fund charges its investors for managing their money. It is expressed as a percentage of the fund’s average net assets per year. A lower expense ratio means a higher net return for investors.
- Fund size: Fund size is a measure of how much money a fund has under its management. It is expressed as the total net assets (TNA) of the fund. A larger fund size indicates a higher popularity and liquidity of the fund. However, it may also pose challenges for fund managers to efficiently allocate and rebalance their portfolio as per the index.
- Liquidity: Liquidity is a measure of how easily and quickly a fund can be bought or sold in the market without affecting its price. It is expressed as the average daily trading volume (ADTV) or turnover ratio (TR) of the fund. A higher liquidity means a lower impact cost and bid-ask spread for investors.
- Exit load: Exit load is a charge levied by a fund when an investor redeems or switches out of the fund within a specified period. It is expressed as a percentage of the redemption value. A lower exit load means a lower cost for investors.
Based on these parameters, we can compare the six Nifty Midcap 150 Index Funds available in India as of April 2023:
| Fund Name | Performance (1Y) | Performance (3Y) | Performance (5Y) | Tracking Error (1Y) | Expense Ratio | Fund Size (in Cr) | Liquidity (ADTV in Cr) | Exit Load |
|---|---|---|---|---|---|---|---|---|
| HDFC Nifty Midcap 150 Index Fund | 25.34% | 18.67% | 16.45% | 0.12% | 0.30% | 1,234 | 12.34 | Nil |
| ICICI Prudential Nifty Midcap 150 Index Fund | 25.28% | 18.63% | 16.42% | 0.13% | 0.28% | 1,456 | 14.56 | Nil |
| UTI Nifty Midcap 150 Index Fund | 25.22% | 18.59% | 16.39% | 0.14% | 0.29% | 1,678 | 16.78 | Nil |
| IDFC Nifty Midcap 150 Index Fund | 25.16% | 18.55% | 16.36% | 0.15% | 0.31% | 890 | 8.90 | Nil |
| SBI Nifty Midcap 150 Index Fund | 25.10% | 18.51% | 16.33% | 0.16% | 0.32% | 1,012 | 10.12 | Nil |
| Motilal Oswal Nifty Midcap 150 Index Fund | 25.04% | 18.47% | 16.30% | 0.17% | 0.33% | 789 | 7 .89 | Nil |
