Our take on 9 mid-cap funds

The Analyst Rating does not express a view on a given asset class or peer group; rather, it seeks to evaluate each strategy within the context of an appropriate benchmark and peer group. Morningstar's analysts using various parameters to assign ratings. The supreme rating is a Gold, followed by Silver, Bronze, Neutral and Negative.

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UTI Mid Cap

• DATE OF ANALYSIS: February 2023
• ANALYST RATING: Neutral
• ANALYST NAME: Kongkon Gogoi

Fund manager Ankit Agrawal follows a blended strategy with a growth/quality tilt. The strategy seeks to invest mostly (70% of the portfolio) in companies that have a long runway for growth and are run by competent management. In addition, a sizable portion of the portfolio (30%) is dedicated to companies that are currently grappling with transitional issues attributed to their respective sectoral macrocycles. The strategy defines an investable company as one with a successful business model, is run by competent management (having a history of skillful capital deployment), and, more importantly, has a track record of generating a high return on investment.

To select companies for inclusion in the portfolio from the existing universe, the initial quantitative screening process is by determining companies that have generated higher operating profits and long-term returns on equity. The approach emphasizes on the trends and patterns discerned from historical performance than from the forecasts. Based on these two factors, the companies are divided into three tiers each (C1, C2, C3, and R1, R2, R3).

Cash flow tiers are based on the number of years in which companies have generated positive operating cash flows in the preceding five years, while ROCE/ROE tiers are based on the previous five-year average return on capital and consistency in the implied ROE for financials over five years. Based on the views generated during the investment selection processes, the fund manager then tailors a diversified portfolio to meet the risk and return objectives of the strategy and seeks to hold it across multiple economic scenarios.

Risk management considerations are inherent in the process. Exposure limits are clearly defined. While constructing the portfolio, exposure to individual stocks is capped at 6% of assets and the individual sector at 35% of the net assets. Further, exposure to top 10 stocks is limited to 35% of the assets, while cash allocation is maxed at 10%.

Axis Midcap

• DATE OF ANALYSIS: January 2023
• ANALYST RATING: Bronze (Direct), Neutral (Regular)
• ANALYST NAME: Kavitha Krishnan

Fund manager Shreyas Devalkar follows a high-conviction strategy where he invests in high-quality stocks with long-term sustainable growth prospects. The portfolio remains markedly different from its peers as well as its benchmark, owing to the quality of stocks that fit into their portfolio. The manager evaluates companies based on their fundamentals, growth trajectory, corporate governance, financials, and so on. They place a lot of focus on corporate governance and this could lead them away from some companies despite their higher growth trajectory.

The manager chooses stocks based on the PEG ratio as opposed to the P/E ratio of a company. The focus is on being able to identify companies with sustainable earnings growth potential and a credible management. The manager places a lot of focus on the promoters and undertakes a 360-degree approach while evaluating a company by ensuring thorough channel checks are put into place. They also spend time speaking to dealers, distributors, and clients.

Stock-picking is based on a fundamental bottom-up approach with added emphasis on top-down risk parameters, liquidity profile and internal volatility targets. From a financial standpoint, they look for companies with lower capital gearing and strong balance sheets. The research team runs a model portfolio which is essentially a combination of their best ideas and is run based on a three- to five-year view of stocks.

Overall, we think that the investment process is a well-thought one.

SBI Magnum Midcap

• DATE OF ANALYSIS: December 2022
• ANALYST RATING: Silver (Direct), Bronze (Regular)
• ANALYST NAME: Kavitha Krishnan

Fund manager Sohini Andani follows an absolute return mid-cap strategy which aims to invest in her high-conviction ideas. (The AMC differentiates its funds based on absolute and relative return frameworks).

While being conscious of valuations, the team evaluates a company's management and focuses on stocks that are able to meet their threshold in terms of CAGR and a consistent ROCE over a three- to five-year horizon. They lay emphasis on the management and take into consideration the promoter's integrity, past track record, holding in the company, etc. and look at investing in businesses with high entry barriers.The in-house model portfolio forms the basis for stock selection and consists of the team's best ideas. Valuations are looked at on an absolute basis relative to the stock's 10-year history. The fund has largely maintained an orientation towards growth stocks and is focused on long-term (three- to five-year) visibility. We think that their approach towards investing in companies with a high ESG score is a positive measure towards maintaining a ‘clean' portfolio.

The team takes a sector view as a fund house, with stock selection being left to managers who could remain uninvested in sectors wherein they don't find the right opportunities. Andani believes that the opportunity cost of investing in these stocks are fairly high and will exit from them irrespective of the levels that they are trading at. While they avoid event-based investing (possibility of a merger/acquisition, etc.), they tend to invest in IPOs.

Franklin India Prima

• DATE OF ANALYSIS: December 2022
• ANALYST RATING: Silver (Direct), Bronze (Regular)
• ANALYST NAME: Himanshu Srivastava

Fund manager R. Janakiraman selects companies that can generate consistent and sustainable earnings growth over a business cycle and have low leverage and reasonably high ROEs. He is aware that it is difficult to forecast earnings in small/mid-caps; hence, he uses historical five-year data as a yardstick to project five years ahead. He is not very rigid on valuations, so long as the company fulfils his investment criteria.

Fundamental research forms the crux of the investment process. The coverage list for small/mid-caps is built by the portfolio managers in conjunction with the analysts. When selecting companies, the investment team places strong emphasis on qualitative aspects such as managerial strengths and corporate governance; also, rigourous business analysis is performed to understand the growth prospects of the industry, the competitive landscape, entry barriers, and scalability prospects.

The strategy is not without risks. Its valuation-conscious approach and the manager's inability to play momentum will hold the fund back in speculative or bull markets as seen during 2020 and 2021. The fund also struggled owing to a few investment calls that could have been avoided. A more prudent approach would help in this regard. Though the strategy has the potential to deliver superior performance over the long haul, it is tagged with inherent biases along with higher volatility.

HDFC Mid-Cap Opportunities Fund

• DATE OF ANALYSIS: May 2022
• ANALYST RATING: Silver (Direct), Bronze (Regular)
• ANALYST NAME: Kavitha Krishnan

Fund manager Chirag Setalvad emphasizes on understanding the niceties of a business before investing in it. Like all equity managers from the fund company, he adopts a hands-on approach to research, to identify companies with robust business models, strong competitive advantages, and clean balance sheets. Company meetings are an integral part of the evaluation process.

Setalvad looks for tangible business models with a track record. Emerging/niche companies that have untested business models or are at best simply attractive ideas don't find favor with him. The portfolio's top holdings, such as Bharat Electronics and Balakrishna Industries, bear out his approach. He typically looks for companies that can generate reasonable free cash flow and have high ROEs. He combines absolute and relative valuation parameters to select stocks that aren't too expensive relative to their growth prospects.

Broadly speaking, the investment style can be characterised as growth at a reasonable price. The investment process is evidently closer to a bottom-up approach. At its core, the process is reasonably simple and well-defined. For the process to succeed, getting the research right is primary. Setalvad is proficient on that front and has adequate support from the investment team. Also, he has consistently executed the strategy proficiently.

Aditya Birla Sun Life Mid Cap Fund

• DATE OF ANALYSIS: April 2022
• ANALYST RATING: Neutral
• ANALYST NAME: Kavitha Krishnan

Fund manager Anil Shah plies a growth-oriented approach and draws on relative valuation techniques such as price/ earnings, price/book value and enterprise value/EBITDA while picking stocks. He prefers companies that are cheaper than the sector and the broader market but offer sustainable growth prospects. That said, he is not averse to paying more for a company if it has strong growth prospects.

Analysts evaluate stocks from a bottom-up perspective and look at factors like the quality of the management, quality of the business, business model and framework, sustainable return on equity, return on investment, entry barriers, and so on. They will also look at how promoters are invested in their own business and how minority shareholders are rewarded. Analysts assess earnings results on a quarterly basis, and they meet company managements biannually.

Shah also focuses on the top-down and macro factors that govern the markets. He looks at investing in themes that are expected to play out over a three- to five-year horizon and remains invested in a sector/stock until his investment thesis plays out. The portfolio is diversified across 50-70 names, and the manager views this approach as a safeguard against market volatility and stock-specific risk in the portfolio. Overall, we think that the process is well structured but is heavily dependent on the manager's stock-picking ability.

Kotak Emerging Equity Scheme

• DATE OF ANALYSIS: January 2022
• ANALYST RATING: Silver (Direct), Bronze (Regular)
• ANALYST NAME: Kavitha Krishnan

Fund manager Pankaj Tibrewal constructs the portfolio with a bottom-up approach and uses a diversified model-portfolio created by analysts as his initial reference point, but he is not constrained by the same.

Analysts use a combination of quantitative models using relevant ratios such as P/BV, P/E, EV/EBITDA, and so on, as well as other valuation methodologies like DCF models to evaluate stocks. Downside risk is a key focus while taking bets. The manager looks for businesses that have strong entry barriers and sustainable competitive advantages. Corporate governance and liquidity also play a key role in Tibrewal's portfolio. He typically favors growth companies having advantages such as brand name, business capabilities, and/or market shares that generate steady cash flows, have capable management teams, and trade at reasonable valuations. He combines absolute and relative valuation measures to determine the fair value of stocks and invests based on a stock's intrinsic value, valuations versus industry peers, and historical valuations.

The top-down approach is not entirely ignored, as Tibrewal takes sector exposures based on their growth prospects and relative valuations compared with the broader index and with itself on a historical basis. Portfolio constraints are part of risk management across portfolios (conservativeness is followed across AMC) based on the fund house's view, and sector over- and underweightings tend to get reflected across all funds.

ICICI Prudential MidCap Fund

• ANALYST RATING: Under Review
• ANALYST NAME: Melvyn Santarita

Nippon India Growth Fund

• ANALYST RATING: Under Review
• ANALYST NAME: Himanshu Srivastava