Mid-cap value funds 

Investment in the stock market involves adequate knowledge about the available options for effectively balancing risk and returns. Among the various options that exist, mid-cap value funds are prominent because they can combine the growth potential of mid-cap companies with the stability provided by undervalued assets. These funds are mid-capitalisation-oriented. The guide gives an in-depth overview of mid-cap value funds and is helpful for readers at a beginner level to understand how such funds work, as well as their benefits, risks, and performance. 

What are Mid-Cap Value Funds? 

Mid-cap value funds are a particular type of mutual or exchange-traded fund (ETF) that invests in mid-capitalisation companies perceived as undervalued. Mid-cap companies are usually ranked between 101 and 250 regarding market capitalization. These firms have high growth potential but are currently underpriced relative to their intrinsic value. 

Through investments in mid-cap value funds, the investor expects to leverage the play between growth opportunities and comparative stability. Therefore, this type of investment is one of the best that investors looking for portfolio diversification can make, but it cannot withstand the increased risks attributed to small-cap stocks. 

Understanding Mid-Cap Value Funds 

Mid-cap value funds are a great middle option for investors who want to enjoy more growth potential than large-cap funds but do not want to experience the fluctuations of small-cap funds. They provide a diversified approach by targeting companies that are not only undervalued by the market but also have strong fundamentals and ample scope for future growth. 

Key Characteristics 

Mid-cap value funds stand out in the investment landscape due to the following unique characteristics: 

• Market Capitalisation Range: This fund caters to mid-cap companies with market capitalisations between US$2 billion and US$10 billion. 

• Investment Strategy: This type of fund focuses on companies considered undervalued by some measure, such as P/E or P/B. 

• Risk Profile: It is slightly more risk-prone than small-cap funds but still less volatile than large-cap funds. 

• Growth Potential: Mid-cap firms tend to have more significant growth potential than large-cap stocks; however, they are not nearly as stable. 

Investment Mechanics 

Mid-cap value funds usually invest at least 65% of their portfolio in mid-cap equity. The companies must represent the following characteristics: 

• Economic Health: Companies have low debt, strong cash flow, and good earning reports. 

• Future Growth Prospect: Organisations in growth-friendly industries or markets. 

• Attractive Valuations: Stocks that are selling at a discount to financials. 

• Proven Business Models: Companies with consistent operations and market presence. 

Performance Metrics of Mid-Cap Value Funds 

Mid-cap value funds have shown great long-term performance compared to other funds. They have managed to deliver: 

• 5-Year Average Returns: 8–10% per annum. 

• 3-Year Average Returns: Usually over 20% when the market is in good form. 

• 1-Year Returns: About 11% as per the market trends. 

Risk and Volatility 

Though the potential returns of mid-cap value funds are pretty attractive, they come with specific risks: 

1. Market Volatility: Mid-cap stocks may have sharp price movements during economic downturns or corrections.
2. Liquidity Concerns: Mid-cap stocks have relatively lower trading volumes than their large-cap counterparts, affecting liquidity.
3. Economic Sensitivity: These funds are sensitive to macroeconomic factors like interest rates and inflation.

Investors must maintain a long-term outlook to overcome short-term volatility and reap maximum returns. 

Fund Management of Mid-Cap Value Funds 

Management of mid-cap value funds depends on their performance and compliance with investor objectives. Active and passive management are among the most popular fund management strategies. 

Active Management 

Active management is a ‘hands-on’ approach in which fund managers actively seek out, select, and change the fund’s portfolio according to market conditions and stock performance. 

1. Stock selection: In active management, the fund manager uses intensive research and analysis to discover companies with low P/E ratios and strong cash flows that are undervalued by the markets.
2. Dynamic Adjustments: Periodic portfolio adjustments to changes in market trends, economy, or company-based events.
3. Flexibility: With scope for nimble manoeuvres whenever opportunities seem to materialise, thus making a particular fund sometimes perform better than the indexes in benign time.
4. Greater costs: Greater research activity combined with trade execution can lead to bigger management expenses, leading to slightly lower bottom lines.

Passive Management 

Passive management relies on matching the performance of a specific index, such as the S&P MidCap 400 Value Index. 

1. Index Tracking:  Passive mutual funds are tailored to correspond to the indices they replicate by holding stock portfolios exactly in a proportion similar to their index.
2. Lower Expense Ratios: Since passive funds do not require extensive research or active trading, their management fees are significantly lower and, hence, more cost-effective for investors.
3. Market-Aligned Returns: Passive funds seldom outperform the market but provide steady returns closely aligned with their benchmark indices.
4. Simplicity: This strategy is most appropriate for investors who like a simple, hands-off investment.

Selection Criteria for Fund Managers 

Irrespective of the type of management, effective mid-cap value funds require managers who have experience and determine the investment based on multiple fundamental factors: 

1. Financial Power Strength: The manager will conduct debt-to-equity ratios, earnings growth, and cash flow analyses in financially strong developing firms.
2. Growth Potential: The firm’s future growth potential would be measured by the manager’s understanding of industry trends, technological improvement, and market demand.
3. Valuation Metrics: Managers seek undervalued companies with low P/E and P/B to buy at a discount and enjoy the ride as the valuations will increase.
4. Sector Diversification: The fund is structured to consist of stocks from multiple industries, reducing sector-related risks.
5. Quality of Management: The management team’s ability, in terms of their past performance and strategic vision, is a significant factor influencing investment decisions.

Examples of Mid-Cap Value Funds 

US Market Examples 

1. Vanguard S&P Mid-Cap 400 Value ETF (IVOV)

• Description: It provides access to the S&P MidCap 400 Value Index, focusing on middle-cap companies with an efficient foundation. 

• Performance: Returns 8.39% per annum over 5 years. 

• Expense ratio: 0.15% 

• Advantages: A portfolio that is diversified over the sectors and a good option for long-term investors 

2. SPDR S&P 400 Mid Cap Value ETF (MDYV)

• Overview: Exposes investors to mid-cap companies that are undervalued on market metrics. 

• Performance: It has delivered strong historical returns, with a 10-year excess return of about 1.3 percentage points above the peer average. 

• Strengths: The portfolio is well structured, balancing risk and growth. 

Singapore Market Example 

For investors in Singapore, mid-cap value funds may not be as readily available, but ETFs or unit trusts tracking mid-cap indices are available for similar exposure. Tools like the POEMS platform allow access to international mid-cap funds, including US-based funds. 

Frequently Asked Questions