Mid-caps vs large-caps — The three-year record

Which fund category is likely to yield better returns — one focused on large-caps or mid-caps?
Well, while the argument may be a never-ending one, large-cap funds appear to have edged out the latter over a three-year period. Midcap funds, typically known for their higher risk-return ratios, seem to have lost the returns race, albeit only during the specified period.
We compare here the performance of the two fund categories over a three-year period as it is a reasonable time-frame to assess performance and is a typical time horizon for an investor. Besides, with the market recording sharp rallies as well as steep declines over this period, it would also be an effective time-frame to measure the accomplishment of funds.
Large-caps outperform
Between December 2006 and December 2009, about 25 funds focused on mid-cap stocks delivered a compounded annual return of 7.8 per cent. The large-cap focused funds (38 funds), in comparison, delivered better, with average returns pegged at 10.5 per cent. That said, both the categories, however, beat their respective representative index in the BSE.
But even as the averages may portray mid-cap funds as underperformers, that wasn't necessarily the case. In fact, if one were to look at the top performers among the two market-cap fund categories, mid-cap funds such as IDFC Premier Equity (25 per cent) and Sundaram BNP Paribas S.M.I.L.E (19 per cent) delivered better returns than even the best performing funds in the large-cap category. The top three large-cap funds — Baroda Pioneer Growth, HDFC Top 200 and Templeton India Growth had only about 18 per cent return to their credit.
Despite superior performers in this segment, why have mid-cap funds as a category underperformed the large-cap universe? This can be attributed to the sharp divergence in the performance of mid-cap funds and the significant declines in this category in 2008, when mid- and small-cap stocks bore the brunt of the bear attack.
Over the three-year period, while the difference in returns between the best (25.5 per cent) and worst fund (-7.8 per cent) in the mid-cap segment was about 33 percentage points, it was restricted to about 20 percentage points in the large-cap universe.
Similarly, between the market highs in December 2007 to the lows in March 2009, while midcap funds on an average declined by about 69 per cent percent, their large-cap peers managed to contain similar-period declines better at about 58 per cent. However note that mid-cap funds had a rolling year in 2006, 2007 as well as 2009; one bad year (2008) in between appears to have done all the damage.
Lessons: Active review and occasional profit booking rather than a mere ‘buy-and-hold' may be a superior strategy while investing in mid-cap funds.