FundsIndia Recommends: L&T Midcap

L&T Midcap is an achiever on three counts. One, it returns better than the market during rallies while also containing losses on corrections. Two, it delivers among the best risk-adjusted returns. Three, it is a steady outperformer across the years.

The fund delivers well as it holds a diversified and liquid portfolio, gradually builds up positions in stocks, regularly books profits, and also exits underperformers or overvalued stocks. L&T Midcap became a part of the Select Fund list in our December quarter review.

Suitability

The fund suits high-risk investors with a minimum timeframe of 5 years. The steep correction in the midcap space offers good opportunities; the recent market rally has already shown recovery starting in the midcap and smallcap space. Post-election volatility also offers good opportunities. Lump-sum investments followed by SIPs, or simple SIP investments will help capture opportunities effectively.

Performance

L&T Midcap’s average 3-year return since 2014 is 26.2%, stacking up well against the Nifty Midcap 100 TRI’s 19.5% and the category’s 22.5%. Average returns are similar to similarly aggressive funds such as HDFC Midcap Opportunities and Kotak Emerging Equities.

Against the Nifty Midcap 100 TRI, L&T Midcap outperforms all the time when rolling-year returns over the past five years. On this front, it is the best in the category, including HDFC Midcap Opportunities, Franklin India Prima, and Kotak Emerging Equity. It has shown a good ability to deliver outstanding returns during market uptrends, often topping the category or ranking in the top quartile in terms of margin of outperformance.

When it comes to market corrections, L&T Midcap is certainly not the best in the category in containing downsides – that position is held by Franklin India Prima. However, Franklin Prima doesn’t do as well in capturing upsides, due to its more conservative approach.

L&T Midcap falls to a lesser extent than the index itself. For the calendar year 2018, for instance, the fund lost 11.8% compared to 14.4% of the Nifty Midcap 100 TRI. Using the capture ratio to measure the ability to contain downsides also shows L&T Midcap in a good light. Therefore, L&T Midcap stands out by being among the best at delivering on the upside while also keeping losses in check.

Returns as of 26 April, 2019. Returns over 1 year are annualized.

The fund is also more volatile, as it frequently buys and sells stocks. However, the fund still delivers the best risk-adjusted returns (measured by the Sharpe ratio). The fund is also among the toppers in SIP returns across timeframes.

Strategy and portfolio

L&T Midcap holds a large portfolio of stocks with limited exposure to individual stocks. Exposure rarely goes above 5%. This is the norm with most midcap funds. Midcap investing is generally very stock-specific and not an overall sector-based allocation. Still, L&T Midcap manages a balanced approach across consumer, cyclical, and finance themes. It looks for stocks that have a competitive advantage over peers and reasonable valuations.

The fund takes time to build up positions in stocks, which can help limit impact costs. Stocks such as Shree Cement, Thermax, Sundaram Finance, Sundaram Fasteners, Ashoka Buildcon, and so on, saw steady increases. The fund has also used market corrections to pick up stocks, adding to names such as City Union Bank, RBL Bank, and Exide. Over the past year, banking and finance, pharmaceuticals, cement, industrials, capital goods, auto ancillaries, retailing, and other smaller consumer themes have seen additions.

L&T Midcap also actively books profits on stocks. This ensures it is able to translate paper gains into actual gains. The fund’s portfolio churn spiked in mid-2017 when the heady market allowed good profit-booking opportunities. For instance, the fund made gains off Graphite India, United Spirits, Jyothy Labs, Marico, South India Bank, and Bajaj Finserv over 2017. It also helps that the fund holds liquid stocks – 70% of its latest portfolio can be liquidated in a week.

Apart from active portfolio management, L&T Midcap takes cash calls going up to 10-12% of the portfolio. This both contains downsides and enables the fund to gradually deploy inflows. The fund’s manager is SN Lahiri and Vihang Naik, and the fund’s AUM is ₹4,390 crore.