Your Question Answered: I want to invest in Nifty Midcap 150 Index. Please elaborate its pros and cons

I am a young professional working in the accounts team of an MNC. My wife is also working in the same company in the marketing department. We have been investing in large-cap indices since the past 5 years. However, we now intend to diversify and invest in mutual funds which have the potential of giving decent returns. Our acquaintances have suggested investing in the midcap sector and exploring mutual funds tracking the Nifty Midcap 150 Index. Can you please elaborate on the differences between the large-cap and the mid-cap sector and the pros and cons of investing in an index mutual fund tracking the Nifty Midcap 150 Index?

Abish Gonsalves, Chennai, Tamil Nadu

Large-cap vs. Mid-cap segment

In the diverse world of stock market investing, understanding the nuances between different types of stocks is crucial for making informed decisions. The Securities and Exchange Board of India (SEBI) provides a clear classification system that helps investors navigate through large-cap and mid-cap stocks.

Large-cap sector

Large-cap stocks represent companies that are the top 100 listed companies in terms of market capitalization, i.e., the value of their shares in totality. Conservative investors often favour large-cap stocks for their reliability and consistent performance. They are considered a safer investment compared to mid-cap and small-cap stocks, as they are less volatile during market fluctuations. However, this stability also means that large-cap stocks may offer lower returns compared to their mid-cap counterparts.

Mid-cap stocks

Mid-cap stocks, as per SEBI's classification, are those companies that rank from 101st to 250th based on total market capitalization. Investors investing in these companies are typically trying to strike a balance between the growth potential of small-cap stocks and the stability of large-cap stocks.

Mid-cap companies are often in the growth phase of their business cycle, expanding their market share and exploring new opportunities. This makes them an attractive option for investors looking for higher growth potential. However, with higher potential returns comes increased risk, as mid-cap stocks can be more sensitive to market volatility.

The SEBI classification system

SEBI's classification system is designed to provide a standardised approach to categorising companies based on market capitalization. This system helps in creating a more structured investment environment and aids mutual funds in creating diversified portfolios.

The market capitalization of companies is reviewed every six months, using data from the end of June and December each year. This ensures that the classification remains current and reflects the latest market conditions.

Making the right investment choice

When choosing between large-cap and mid-cap mutual funds, investors must consider their investment goals, risk tolerance, and the time horizon of their investment. Large-cap mutual funds are suitable for those seeking stability and long-term growth, while mid-cap mutual funds are better suited for investors willing to take on more risk for the possibility of higher returns.

It's also important to note that diversification is key in managing risk. A balanced portfolio that includes both large-cap and mid-cap mutual funds can provide a mix of stability and growth potential.

Nifty Midcap 150 Index

The Nifty Midcap 150 Index, a barometer of India's mid-sized companies' market performance, is a pivotal index for investors looking to tap into the growth potential of midcap stocks. Representing the next 150 companies based on full market capitalization from the Nifty 500 after the top 100, the Nifty Midcap 150 is a diversified index that captures the market movements of mid-tier Indian companies.

Understanding the Nifty Midcap 150 Index

The Nifty Midcap 150 Index is designed to reflect the behaviour and performance of the mid-market capitalization segment of the financial market. The index is a significant indicator of the Indian economy's mid-segment.

Nifty Midcap 150 Index - Eligibility and constituents

Eligibility Criteria for Inclusion in the Nifty Midcap 150 Index:

Part of Nifty 500: To be considered for inclusion in the Nifty Midcap 150, a company must already be part of the Nifty 500 Index. This ensures that only companies that have already met the stringent listing criteria of the broader Nifty 500 are considered for the Midcap 150 index.

Ranking based on market capitalization: Companies that rank among the top 225 based on full market capitalization are eligible for inclusion. This criterion ensures that the index captures the performance of companies that are significant in size and have a substantial presence in the market.

Market capitalization threshold: A company's full market capitalization should be at least 1.5 times that of the last constituent of the Nifty Midcap 150. This requirement is designed to maintain the quality and stability of the index by including companies that have a relatively larger market capitalization, which can contribute to the robustness of the index.

Free float market capitalization method: The index is computed using the free float market capitalization method. This means that the level of the index reflects the total market value of the free-floating shares of the companies in the index relative to a base market capitalization value.

Review and rebalancing: The index is reviewed and rebalanced periodically. This process ensures that the index remains representative of the mid-market capitalization segment of the Indian equity market. During the review, companies that no longer meet the eligibility criteria may be excluded, and new companies that meet the criteria may be included.

The Nifty Midcap 150 Index not only reflects the performance of mid-sized companies but also provides insights into the economic trends affecting this segment of the market. For investors, understanding the eligibility criteria is crucial for making informed decisions, especially when considering index-based investment products.

Investment and opportunities

Investing in the Nifty Midcap 150 Index tracking mutual funds can be a strategic move for those looking to diversify their portfolio beyond the large-cap stocks. Midcap stocks often offer a balance between the growth potential of small-cap stocks and the stability of large-cap stocks. They are particularly appealing to investors who are willing to take on a moderate level of risk for potentially higher returns.

Performance and returns and comparison With Nifty 50

As of July 31, 2024, the Nifty 150 Midcap Index has given a one-year return of 55.53%. It has given a 5 year compounded annual gross return of 31.58%. On the other hand, as of July 31, 2024 Nifty 50 Index has given a one-year return of 27.84%. It has given a 5 year compounded annual gross return of 18.92%. Please see below the top 5 index mutual funds (direct schemes) tracking the Nifty Midcap 150 Index basis their 1-year performance. 

Source: AMFI; as of 27 August 2024

Note: Past performance is not an indication of future returns.

Pros and cons of investing in index mutual funds tracking Nifty Midcap 150 Index

Index mutual funds have become a staple in the investment portfolios of many, offering a passive investment strategy that aims to replicate the performance of a benchmark index. It is crucial to weigh the pros and cons to make an informed decision.

Pros

Diversification: One of the primary advantages of investing in these funds is the diversification they offer. By tracking the Nifty Midcap 150 Index, investors gain exposure to a basket of 150 mid-sized companies, spreading out the risk that would be present if investing in individual stocks.

Cost-effectiveness: Index funds are known for their lower expense ratios compared to actively managed funds. This is because they are passively managed, eliminating the need for a fund manager to actively select stocks, which can lead to significant cost savings over time.

Simplicity: For new investors, index funds offer a straightforward approach to investing. There's no need to research individual stocks; instead, one can invest in a broad market segment through a single financial product.

Performance: Historically, midcap stocks have provided higher returns than large-cap stocks over the long term, albeit with higher volatility. This could potentially lead to better growth opportunities for investors willing to accept the associated risks.

Cons

Market risk: While diversification can mitigate some risk, investing in midcap stocks comes with higher market volatility. This means that the fund's value can fluctuate more significantly in the short term, which might not be suitable for all investors.

Sector concentration: The Nifty Midcap 150 Index may have a concentration in specific sectors, which can lead to sector-specific risks. If a particular sector underperforms, it can adversely affect the overall performance of the fund.

Taxation of investment made in mutual funds tracking the Nifty Midcap 150 Index

The Union Budget 2024 has introduced pivotal changes in the taxation of equity index mutual funds, which are poised to significantly affect investors' strategies and returns. This detailed analysis below aims to elucidate the new tax regulations and their implications for mutual fund investors investing in mutual funds tracking the Nifty Midcap 150 Index.

Long-term capital gains

One of the most notable changes is the increase in the LTCG tax rate on equity-oriented investments from 10% to 12.5%, effective from July 23, 2024. This hike applies to gains exceeding the revised exemption limit of INR 1.25 lakh per annum, up from the previous INR 1 lakh. The removal of the indexation benefit, which allowed adjustment of the purchase price for inflation, further impacts the tax efficiency of long-term investments.

Short-term capital gains

The STCG tax rate on specified financial assets, including equity mutual funds, has risen from 15% to 20%. This increase aligns with the government's approach to streamline the tax structure and potentially dissuade short-term speculative investments.

Categorization and holding periods

Post-Budget 2024, mutual funds are categorised for taxation based on their portfolio composition and holding periods. Equity mutual funds are those with more than 65% of their portfolio in Indian stocks, and they can avail of LTCG benefits after a holding period of over 12 months. Index mutual funds tracking the Nifty Midcap 150 Index are classified as equity mutual funds.

Conclusion

The Nifty Midcap 150 Index is more than just a market indicator; it's a gateway to India's burgeoning midcap sector, offering a blend of risk and reward. For investors looking to capitalise on the growth of mid-tier companies, the Nifty Midcap 150 presents a compelling option. With its comprehensive representation of the mid-market capitalization space, the index serves as a crucial tool for portfolio diversification and investment strategy.

Index mutual funds tracking the Nifty Midcap 150 Index offer a blend of opportunities and challenges. They provide a cost-effective, diversified, and simple investment option with the potential for substantial growth. However, investors must also consider the risks of market volatility, limited upside potential, tracking errors, and sector concentration. As with any investment, it's essential to align your choice with your financial goals, risk tolerance, and investment horizon. Consulting with a financial advisor can also help tailor your investment strategy to your unique needs.

Investing is a journey that requires careful planning and consideration. By understanding both the pros and cons of index mutual funds tracking the Nifty Midcap 150 Index, investors can navigate the complexities of the market and make choices that best suit their long-term financial aspirations.

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