“Quality is never an accident; it is always the result of intelligent effort”
— John Ruskin, English writer and critic
Usually, when someone speaks about the quality of life, they refer to the quality of sleep, meals, exercise and work-life balance. The better invested they are in the above factors, the higher their quality of life can be. And, when someone describes the quality of the city they live in, they attribute it to the quality of infrastructure, housing, conveyance and the overall standard of living.
Similarly, multiple factors influence an investment to make it a quality option. Now, Quality may be defined by various dimensions such as Profitability, Earnings potential, Financial Leverage, Asset Growth and Corporate Governance.
To build a portfolio of fundamentally sound mid-cap companies, a combination of such quality factors would be used with an aim to generate better risk-adjusted returns in a medium to long-term investment horizon.
What is Quality Investing?
Quality investing is a well-accepted and globally proven concept that aims at consistent performance across different market conditions and investment cycles. This type of investing aims at return generation with lesser volatility, with investments into companies that have relatively stronger balance sheet, higher return of equity and stability of earnings, which are also less susceptible to recessions and other macroeconomic events. Therefore, quality companies tend to hold up better during turbulent market conditions.
Why is quality selection important for mid-cap investing?
Long-term performance analysis suggests that mid-caps have generated better returns than large caps. Therefore, while investing in a portfolio of mid-caps is a preferable way to diversify investments, it may also enhance the overall portfolio performance.
Nifty Midcap 150 Index has delivered 14.5% annualized returns on three years rolling returns since inception (April 1, 2005 to June 30, 2022) as compared to 12.2% for Nifty 100 Index. However, volatility is also higher for Nifty Midcap 150 Index at 6.8% as compared to 4.9% for Nifty 100 Index. Therefore, portfolio volatility may reduce by investing in quality companies within mid-cap space, improving risk- adjusted returns.
However, there is a perception among investors that mid-cap stocks are relatively more volatile as compared to large-cap stocks. This is partly true, as some risks are directly related to the size of the company, nature of the business and other corporate governance issues. Further, mid-caps stocks are also under-researched, and they may overreact to quarterly financial results i.e., they may perform exceedingly well after good results and vice versa. Therefore, investment in mid-cap companies requires a lot of research as mid and small size companies have higher financial risk.
Having quality factor can often help in addressing some of these issues, since quality companies are generally consistent in terms of earnings growth and profitability. Quality companies, with stronger balance sheets and consistent higher profitability, are also more resilient during adverse economic events. Further, quality companies have far better pricing power and they may be capable of passing on some of the price hike during tough market environments.
Investors looking to invest in quality mid-cap stocks may choose to invest in a portfolio of companies consisting of quality mid-cap or a passively managed fund following Nifty Midcap 150 Quality 50 Index. This index evaluates the stocks based on pre-defined quality factors to build a diversified portfolio of quality mid-cap companies.
The Nifty Midcap 150 Quality 50 Index is constituted by selecting 50 high-quality companies from its parent Nifty Midcap 150 Index. The ‘quality score’ for each company is determined by three quality factors: Return on Equity, Financial Leverage (except financial services companies) and Earnings per Share Growth Variability (based on previous five financial years). The weight of each stock in the index is based on a combination of the stock’s quality score and its free float market capitalization, wherein the weight of each stock is capped at 5%.
Currently RoE of Nifty Midcap 150 Quality 50 Index is 29% vs 18% for Nifty Midcap 150 Index with lower financial leverage and consistency of earnings growth. Strong balance sheet and better return ratios have helped quality index to deliver 18% annualized profit growth in last five years as compared to 11% for Nifty Midcap 150 Index.
Based on the current performance, Nifty Midcap 150 Quality 50 TRI delivered better risk- adjusted returns compared to Nifty Midcap 150 TRI over medium to long-term investment horizon. The following graph illustrates the same:
Data as of September 30, 2022. TRI i.e., 'Total Return Index’ consider reinvestment of dividends issued by companies forming part of Index. Source: MFI Explorer & NIFTY Indices Limited. Returns are CAGR. Standard Deviation is based on the daily returns for the respective period. Since Inception – April 01, 2005 – September 30, 2022. Past performance may or may not be sustained in the future and shall not be used for comparison with other investments. The figures pertain to performance of the index and do not indicate the returns/performance of the scheme. It is not possible to invest directly in Index
UTI Nifty Midcap 150 Quality 50 Index Fund is a diversified portfolio of high-quality companies with relatively higher exposure to structurally high-quality and high-growth sectors such as IT, Healthcare, Chemicals and Capital Goods.
Historically, quality index offers downside protection during adverse economic events while capturing a large part of the upside growth during market rallies. As a result, the strategy has successfully delivered better risk-adjusted returns than Nifty Midcap 150 TRI for a medium to a long-term investment horizon. Therefore, one may choose to play “Quality” in midcaps and aim to score-high over medium to long-term.
Furthermore, Nifty Midcap 150 Quality 50 Index can protect investors through turbulent times. The following graph throws more light into this:
Source: NIFTY Indices Ltd as on September 30, 2022, based on Total Returns Index. Index Inception Date is 01 April 2005. Past performance does not guarantee future performance of the scheme. Past performance may or may not be sustained in the future and shall not be used for comparison with other investments. The figures pertain to performance of the index and do not indicate the returns/performance of the scheme. It is not possible to invest directly in Index
Investing in mid-cap space is critical for investment diversification, since it has better growth potential than many large-cap companies. However, the challenge with mid-cap investing is higher volatility, something that many investors may not be comfortable with. One way to bring down volatility in performance is by investing in quality mid-cap companies, which have higher potential of long-term growth.
UTI Nifty Midcap 150 Quality 50 Index Fund is suitable for:
- Investors looking for exposure in the mid-cap segment, while investing in quality businesses that may generate economic value
- Investors looking for a passive fund, which brings a disciplined approach to the portfolio construction, while adhering to the defined quality selection process
- Investors looking for a cost-effective and smart-beta investment option
- Investors looking for an investment time horizon of five years or above
We can conclude by stating that investing in quality mid-caps can protect investors from drawdowns and minimise risks. Such investments can also strengthen the performance of investment portfolios and could lead to relatively better risk-adjusted returns.
Product Label:
| UTI Nifty Midcap 150 Quality 50 Index Fund
An open-ended scheme replicating/ tracking Nifty Midcap 150 Quality 50 Total Return Index (TRI) This product is suitable for investors who are seeking*:
*Investors should consult their financial advisers if in doubt about whether the product is suitable for them. Risk-o-meter for the fund is based on the portfolio ending July 31, 2022. The Risk-o-meter of the fund/s is/are evaluated on monthly basis and any changes to Risk-o-meter are disclosed vide addendum on monthly basis, to view the latest addendum on Risk-o-meter, please visit addenda section on https://www.utimf.com/forms-and-downloads/ |
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