31

CHAPTER 2

REVIEW OF LITERATURE

A number of studies have been undertaken by various individuals and institutions on

the mutual fund. Such studies have enabled the researcher to have a deep insight

into the existing state of securities market. In addition, the previous studies have also

enabled the researcher to identify the changing outlook of midcap funds in the

present day. This chapter examines in a nutshell, the previous studies conducted by

various scholars both in India and abroad.

The major source for the survey of literature are articles, which have come up in

various Indian and international journals and magazines. Extensive uses of web and

libraries have been used for the literature survey.

For the sake of convenience, this study has been presented in two sections. While

the first section highlights the studies relating to individual investors, reforms in

securities market, overview of individual investors and the second section highlight

the studies relating to midcap funds.

 32

SECTION I

Section 1 deals with studies relating to individual investors and reforms in securities

market, overview of individual investors.

The RBI1 conducted its survey of ownership of shares at the end of 1959, 1965, and

1978. The 1959 study found that the number of individual shareholders accounted

for 98.9% of the total number of shareholders and in value they held 52.05%. The

holding of 52% in India compared well with 55% reported in UK and 51% in USA.

The 1965 survey found the value of individual share holders ownership to decline to

45.6%. The study also found that shareholding up to Rs.50,000 of paid up value of

ordinary share capital was held mostly by individuals (around 92%) and share

holding exceeding Rs.50,000 were comparatively small and insignificant. The

pattern of ownership in favor of large financial institutions was comparable to the

secular trends observed in the studies in U.K and U.S.A.

CHOTTINER SHERMAN2 in the article entitled Optimum investor-stock market

efficiency standard has thrown light on evaluation of the investor performance in the

stock market. According to him, knowledge of perfect performance is valuable as it

will provide a Universal standard of stock market performance. Actual decision rules

can then be compared using the efficiency measures. A measure of a decision rules

1
RBI Survey of ownership of shares in the joint stock companies as at the end of Dec 1954 RBI bulleting May
1962 pp 677-685.

2
Chottiner Sherman, Optimum investor stock market efficiency standard, Financial Analysis Journal Jan-
Feb 1964 Pg: 57.
 33

deviation from optimality. This measure would provide insight into our understanding

of market movement. Also, it would assist in determining how much research it is

feasible to do in order to develop more rewarding decision rules. The research into

perfect performance resulted in many interesting by products such as the severity of

market fluctuations over the years, the effect of increasing commissions on

performance and the optimum trading activity.

TREYNOR J L3 recognised that the major problem in evaluating the performance of

portfolio managers was in measuring the risk of portfolios. In order to define the

relationship between the rates of return for a portfolio over a period of time and

corresponding rates of return for an appropriate benchmark portfolio, he invoked the

concept of the measuring the risk based on the slope of the regression line. He

developed a measure of performance that would apply to all investors irrespective of

their risk preferences. Risk adverse investors would prefer lines that have larger

slopes as this would place them on a high indifference curve. If the market is in

equilibrium, the ratio of excess mean return to the assets beta will be the same for

all assets, and will equal the excess mean rate of return on the market portfolio.

Treynors measure has similarities to the Sharpes (1966) measure. However, it

differs from Sharpes measure in that it relies on systematic risk or of the portfolio

as against Sharpes measure, which uses the standard deviation of returns as the

measure of risk.

3
Treynor, J.L. (1965), How to Rate management of investment funds, Harvard Business Review Vol.43 PP.389-
416
 34

WILLIAM F SHARPE4 (1966) attempted to bring to bear on the measurement and

prediction of mutual fund performance some of the results of recent work in capital

theory and the behaviour of stock market prices. He had shown that performance

can be evaluated with a simple yet theoretically meaningful measure that considers

both average return and risk. This measure precludes the "discovery" of differences

in performance due solely to differences in objectives (e.g., the high average returns

typically obtained by funds that consciously hold risky portfolios). However, even

when performance is measured in this manner there are differences among funds;

and such differences do not appear to be entirely transitory.

To a major extent they can be explained by differences in expense ratios, lending

support to the view that the capital market is highly efficient and that good managers

concentrate on evaluating risk and providing diversification, spending little effort (and

money) on the search for incorrectly priced securities. Sharpes measure evaluates

the performance of the portfolio manager not only on the basis of the returns but also

on the extent and degree of diversification of the portfolio attained. If the portfolio is

fully diversified, implying that it does not contain any nonsystematic risk.

4
William F Sharpe (Jan., 1966), Mutual Fund Performance, The Journal of Business, Vol.39, No.1, Part 2:
Supplement on Security Prices, PP.119-138.
 35

Mc KELVEY5 in his study entitled Intangible factor in stock evaluation pointed out

that when making an investment decision, one should look for certain factors beyond

current earnings and dividends. The factor suggested in his study are growth trend,

quality of growth, qualitative factors, management factors, validity of earnings, use of

leverages, diversification, shareholder relations and other intangible factors. The

intangible factors are stocks with restricted voting rights, full voting right, reputation

of the underwriter and the length of time that the shares have been marketed. The

study emphasises that current earnings and yield are important factors in

determining the attractiveness of a stock, but they are not the only ones. The

findings of a study on the behaviour of individuals in security investment decisions by

KELLER are as follows:

Although each decision process was highly individualised, it was possible to

synthesize the size of a multi step general model. The expectation of desirable future

reported earnings to be generated from adequate company resources by a good

management is a requisite to any investment.

Financial leverage in a company under consideration for investment has some

optimal range relative to adequate resources and risk.

Dividend has value only for their possible information content and any yield floor

was considered to be beyond the range of acceptable down side risk and therefore

5
Keller R. Fronk, The behavior of individual in security investment decisions, dissertation at Harvard
Business School, 1967.
 36

of no consequences. Investors tend to identify with their investments and any

particular stock was rarely regarded dispassionately as a mere portfolio item.

Potential market realisation was the hall-mark of success even among investors who

held that any sale was unjustified unless the original purchase had been a mistake.

WESTERFIELD6 in his study A Behavioural approach to the investment

management decision and to the securities markets examined the individual

investment decision. The major findings may be summarised as follows; there is a

significant difference between an amateur investor and non investor with respect to

risk performances. Certain personality and cognitive judgemental factors are

associated with choice rationality, perceived risk and risk preferences.

JENSEN M C (1968)7 constructed a measure of absolute performance on a risk

adjusted basis and evolved a definite standard against which the performance of

various funds could be measured. This standard provides a basis to measure the

portfolio managers predictive ability, i.e. his ability to earn higher returns through

prediction of security prices given the risk profile of the portfolio. His measure is also

based on the concept of Security Market Line. The ex ante SML represents the

expectations of different investors from investments bearing different risks levels.

The ex post SML, however, represents the behaviour of actual returns. The average

6
Westerfield Rondolph, A Behavior Dissertation at University of California 1968.

7
Jenson, M.C. (1968), The Performance of Mutual Funds in the Period 1954-1964, Journal of Finance,PP.389-
416.
 37

return of a fund performing exceptionally well will be higher as compared to the

return predicted by the SML. Likewise, a poor performance will be characterised by a

return less than that the predicted return by SML.

In a study on what determines the prices of Indian stocks BARMAN8 analysed the

data on stock prices to find out if the changes in stock prices are determined by

fundamentals or bubbles. It has been found that fundamentals are more important in

the determination of stock pricing in the long run. This augurs well for the discerning

investor who can expect to gain by holding good quality portfolio, though the study

did not go into the short term fluctuation of stock prices. However, visual analysis of

data and the known fact of inadequate transparency in the operations of stock

market continue to loom large on likely inefficiency of stock market in the short run.

This state gives a scope for the smart operator to earn abnormally high returns with

excessive volatility. This is a cause for concern for policy makers, in the recent

period. The security Exchange Board of India has initiated certain measures to bring

about higher transparency in the operation of stock market. This effort should be

continued with more vigor to inject efficiency into the stock market even in the short-

run and ensure better climate for mobilisation of fund for investment, so crucial for

economic growth.

8
B.Barman What determines the prices of Indian stocks? Fundamentals or Bubbles. The ICFAI Journal of
Applied Finance, Jan 1969, p-1.
 38

STERN9 has concluded that two broad styles of investing are emerging. They are

firstly gunslinger the aggressive investor who feels he identifies change before the

next guy and capitalise on it. You can identify hishe is young, he is arrogant, he

deals in concepts, not price earnings ratios. He is opportunity-oriented and he

checks out every idea you present to him in a chart book before he acts on it. He

wants access to information and he wants freedom to act quickly. Secondly, we

have the serious long term investor. He is basically interested in earning trend,

concentrates on areas of long term growth and fundamental work. He is less

concept oriented and more price-earnings ratio oriented. He wants access to

information but he wants lots of bits and pieces, which he puts together into a

cumulative appreciative mass, which helps him form long-term judgement. To him

short-term information is not the be-all and end-all. He can be aggressive on ideas,

but on a long term, not on short-term basis.

HATFIELD AND RETLLY10 in a paper on New stock issues found that all tests

shared superior short-run and long-run results for the investors in new stock issues.

This is very strong positively skewed characteristic of the distribution accounted for

the significantly superior results. Although on the average, the investor experiences

as many relative losses as relative gains, his down sides risk is relatively small while

his potential relative gains are substantial. These relatively modest losses probably

can be explained by the fact that the underwriting syndicate can and will support the

9
Stern P.Walter. The investment scene-an overview Financial Analysis Journal Mar-Apr 1969. Pg.109

10
Kenneth Hatfield and Reilly K.Frank, Investor Experience with new stock issues, Financial Analysis
journal sep-oct 1969, pg73.
 39

market for the stock could be sold if it showed an usual strength, it is unlikely that the

underwriting would feel obligated in such a case. These superior results on the

average can partially be justified on the basis of the higher risk assumed by the

investor is uncertain regarding market acceptance of the stock. The results justify

the later point since in all cases, greater dispersion was found in the new issue

distribution of present changes.

CHENNEY11 felt that the value of investment advisory services has long been

questioned. A 12 year study of performances of stocks recommended by 4 top firms

revealed that the scepticism has not been justified. The evidence garnered by the

study pointed out that the subscription advisory services are able to select stocks,

which offer better than average return on investment. That is, they offer advice

which, if followed by the subscribed, promises to provide him with a return on his

investment which is greater than the increase in the Standard and Poors (S&P) 500

composite stock index. In the aggregate, the lists of common stocks recommended

by the advisory services increased in value by 353.3 percent compared with an

increase in value of 25.7% by the S&P 500. Both the percentage includes dividend

income. The above average performance of the advisory services is also true for

their individuals lists of growth stocks, income stocks and for their lists which

combine the income objective with the capital gains objective. The amount of risk

inherent in a portfolio of common stocks is a difficult thing to measure but the

information gathered indicates that the lists of recommended stocks also have

11
Chenney, How good are investment advisory services?, Financial Executive, November, 1969 pg.30.
 40

excellent defensive qualities. The investor is well advised to seek professional help

with his investment programme. The subscription advisory services offer improved

portfolio performance and reduced risk. The defensive strength of the recommended

list reduces the need for protection in the form of diversification and the sound nature

of the recommended lists gives the investors the opportunity to enjoy the satisfaction

of managing their own investment programme to meet their needs with an exception

of better than average rate of returns.

ROGER E. POTLER (1970)12 found empirical evidence suggesting the same basic

factors motivating professional and non-professional investors. The factors were:

desire for income from dividends, rapid growth and quick profits through trading and

purposeful investment as a protective outlet for saving. In a study of financial

disclosure, investor confidence and corporate credibility, CASY emphasized that the

Securities and Exchange Commission, the accounting profession and corporate

executives have no more important job than to make financial reporting more useful,

to overcome investor scepticism and to maintain the credibility of the issuers who

use public saving. There are many reasons why this task must be accomplished.

The fact that the investor in the American Securities market is the most informed and

the best served investor in the world is attracted to invest in American companies,

from all over the world. That makes it possible for U.S. Corporation.

12
Roger E.Potler in Motivating Factor guiding the common stock Investor. The journal of finance 25, Dec,
1970 p-1184.

.
 41

i) To command more capital for a dollar of earnings than their competitors abroad.

ii) To plough back earning which competitors abroad have to distribute to maintain

capital values, and to raise larger amounts of capital more quickly, to apply

technology more rapidly and on a larger scale to bring products to markets around

the world. All this is vital to the economic welfare of 200 million Americans. He also

added that financial executives have further concern that strikes closer to home

investors can have confidence in the economy and in the security market and still

lose confidence in the whole financial reporting process or that of a particular

company. When an industry or a company loses credibility values go down and the

cost of financing goes up.

iii) Will financial forecast really help investors? No one can predict the future with

certainty, yet the management is being asked to publish financial forecast on which

investors will rely in making their investment decisions. Rather than forecast,

managements should release more complete information.

KAPNICK13 says, in recent years; however certain investors may have forgotten the

basic fundamentals of investment risk and have cried foul when they incurred

losses. This has now led some of these who have the responsibility for seeing that

the public investors have sound information to suggest others to assume the

responsibility for evaluating the future because, supposedly the investors who lost

money were unable to make proper evaluations. Public forecasts are not the

13
Sis Kapnick E Hatfield and Reilly K.Frank, Investor Experience with new stock issues, financial Analysis
journal sep-oct 1969, pg-73.
 42

panacea for the investor, that some believe them to be, however everyone must

recognise that the risk in equity securities can result in losses as well as gains and

only the nave could conclude that forecasts will protect overzealous investor from

taking unwarranted risks.

RONALD C. LEASE AND OTHERS (1974)14 found the individual investor to be

primarily a fundamental analyst who perceives himself to hold a balanced and well

diversified portfolio of income and capital appreciation securities. He invests

predominantly for the long run, and is prone to use one of the broad based market

indices as the benchmark to judge personal investment performance results. He

supplements his direct securities purchase activities quite frequently with ownership

of mutual fund shares. Of the money he spends, the great bulk goes towards

subscriptions to standard financial periodicals; their direct market participation has its

origins in consideration of fun as well as profit.

COOLEY15 in his study entitled A multi dimensional analysis of institution investor

perception of risk brought to light the following implication. Proper definition and

measurement of risk are the two basic problems in understanding investment risk.

Although risk is related to uncertainty of future events and more risk implies more

14
Ronald C.Lease Wilbur, G..Lewellen, Gary G. Schlarbaudes The individual investor: Attributes and
Attitudes.

15
Cooley I. Philip, A multidimensional analysis of institutional investor perception of risk, the journal of
Finance, Mar 1977 pg 67.
 43

uncertainty, risk is a personal concept reflected by the view point of a particular

investor. The multi dimensional scaling methodology employed in this study allowed

several portfolio managers to define risk as they personally viewed it in return

distribution. Movement of the returns distribution was then related to the subjectively

derived notions of risk. The results of the above study provide some validating

evidence for financial models based on investors variance aversion. First, nearly

all of the 56 portfolio managers viewed variance as synonymous with risk or at least

an important part of risk. This result would suggest variance as a reasonable risk

surrogate. However, a substantial number of investors associated an additional

dimension with risk namely, asymmetry of return distribution. Increases in risk, for

example, were associated with increase in negative skewness. Kurtosis, although

not an independent dimension was viewed as risk reducing. Less risk appeared

inherent in leptokurtic (more peaked) distribution than in the platykurtic (flatter)

distribution. If all investors are confronted with ex anti-symmetrical return distribution,

perception of asymmetry is irrelevant, whether measured by skewness or some

modification of skewness. Lacking this exogenous condition, the variance-equal-risk

assumption appears suspect for a large group of down side risk is indicated by

association of risk with higher order moments. Findings of this study suggest that

dispersion and asymmetry capture most of what is perceived as risk.

AMAL SANYAL16 in the article Portfolio choice with indivisibility proposed an

alternative or perhaps an additional rationalisation of the diversified portfolio both at

16
Amal Sanyal, Portfolio choice with indivisibility. The Indian Economic journal July Sept 1982 pp22-31.
 44

the micro and at the macro levels, by referring to the fact of substantial indivisibility

involved in the typical portfolio choice problems. He sets up the arguments in the

context of a choice between financial assets (interest bearing deposits) and physical

assets, which available only in multiples of an indivisible minimum unit, rather than in

the context of the liquidity preference theory. He postulated the hypothesis, that the

compounded rate of return on time deposit r is less than compounded rate of return

on price of physical asset, and that there exists perfect certainty regarding both of

these rates as well as regarding the marketability of the real assets at any future

date. As a result, in terms of the usual calculus of the rate of return, the real asset is

preferred to time deposits. However, to highlight the fact of indivisibility, if suppose

the amount of saving of an agent in a single period s is typically less than the

current price p of the minimum unit of the real assets then the latter though

preferred, cant be immediately purchased. The agent has to accumulate his saving

for a number of periods until he can effect the asset purchase. He formalised a

context like this into a simple model and examined some of its properties. It should

already be clear that after an agent has managed to buy a unit of the real asset of all

subsequent dates, he will be generally holding a mixed portfolio, of some real assets,

already bought and some financial assets waiting to be converted into real assets

when feasible in future. From the context, it should be clear that the analysis would

be more suited to the description of the portfolio behaviour of households, rather

than of corporate bodies who may not in general be constrained by the said

indivisibility because of their large size of savings per period. In the context of the

model developed by Amal Sanyal, it is found that not only will there be asset

diversification but also two rather curious results could be proved first is that if r is

lower than the aggregate level, it will induce more rather than less deposit formation
 45

as a proportion of total saving. The second is that if the inflation rate of the real

asset price is higher, and provided that saving is growing fast enough, then there will

be more and not less deposit formation as a proportion of aggregate of savings.

MILNE17 on identifying the decision on determinants of portfolio policies in the case

of individual investors portrayed the association between risk-return preference of

investor and his life cycle. He concluded that in the case of an individual investor, his

risk-return trade off at various life cycle stages depends on his individual

circumstances and risk-taking attitudes. In short, he suggested that an individuals

risk tolerance is unique and subject to changes influenced by the investors wealth

position, health, family situation, age and temperament.

EDWARD F. MRKVICKA18 while describing the motives of rational investor,

concluded that the motivational variables associated with an investment are liquidity,

stability, strength, hedge against inflation, mobility and less time and expenditure

needed to manage the investment. He concluded that mutual fund investment gives

liquidity, stability, strength, mobility and low management cost, which characterise an

ideal investment.

17
Robert D. Milne, Determination of portfolio policies; Individual investor as quoted in John, I Muginn and
David L. Tuttle eds. Managing investment portfolio A dynamic process, New York, Warren Graham and
lament, 1983, pp133-135.

18
Edward F. Mrkvicka Jr., The rational investor common sense advice for winning in stock market, Probas
Publishing company, Chicago, 1991, p-33.
 46

STEPHEN MORRIS19, in his article entitled Speculative investor behaviour and

learning, says As traders learn about the true distribution of some assets, dividends,

a speculative premium occurs as each trader anticipates the possibility of re-selling

the asset to another trader before complete learning has occurred. Small differences

in prior beliefs lead to large speculative premiums during the learning process. This

phenomenon helps explain a paradox concerning the pricing of initial public

offerings. The result casts light on the significance of the common prior assumption

in economic models.

KENT DANIEL, MARK GRINBLATT, SHERIDAN TITMAN, RUSS WERMERS

(1997)20 introduced a characteristic-based benchmark that is designed to measure

whether mutual funds pick stocks that outperform simple mechanical rules. The

evidence presented in this article suggests that the average mutual fund does, in

fact, succeed along this dimension. However, we find that the amount by which the

average mutual fund beats a mechanical strategy is fairly small and is approximately

equal to the average management fee. Aggressive-growth and growth funds, which

exhibit the highest performance, probably also, generate the largest costs. This

19
Stephen Morris, Specualtive investor behavior and learning, paper provided by Federal Reserve Bank of
Philadelphia in its series Working papers with number 96-5. 1996.

20
Kent Daniel, Mark Grinblatt, Sheridan Titman, Russ Wermers (Jul.,1997), Measuring Mutual Fund
Performance with Characteristic-Based Benchmarks, The Journal of Finance Vol.52, No.3, Papers and
Proceedings Fifty-Seventh Annual Meeting, American Finance Association, New Orieans, Louisiana January 4-
6, 1997, PP.1035-1058.
 47

evidence is consistent with an equilibrium, like that of Grossman and Stiglitz (1980),

where informed traders are able to outperform the market just enough to earn back

their fees.

SHAH (1999)21 presented a comprehensive assessment of the impact of reform

measures introduced in the Indian capital market in the nineties and concluded that

developments like sharp reduction in transaction costs, enhanced liquidity, reduced

leverage and evidence of superior information processing by the market agents

contributed to greater efficiency in the market.

R.H PATIL22, The capital Market in 21st Century Noted that stock exchanges, as we

understand them today may not be there in about two decades. The first major

relates to mergers and strategic partnerships among stock exchanges of different

countries. The sum total of the will be the emergence of large global exchanges

beyond the regulatory purview of any national regulator. One should not, thus rule

out the emergence of an international organisation such as the WTO for maintaining

law and order in the global capital market.

21
Shah, Ajay (1999), Institutional change in Indias capital markets, Economic and political weekly, January
16.

22
R.H Patil, The Capital Market in 21st Century, Economic and Political Weekly, November 18, 2000, p-409.
 48

DAVID HIRSHLEIFER23, in his article entitled, Investor Psychology and Asset

Pricing. The basic paradigm of asset pricing is in vibrant flux. The purely rational

approach is being subsumed by a broader approach based upon the psychology of

investors. In this approach, security and expected returns are determined by both

risk and wrong valuation. This survey sketches a framework for understanding

decision biases, evaluates the a priori arguments and the capital market evidence

bearing on the importance of investor psychology for security prices, and reviews

recent models.

S.BALAJI IYER and R KUMAR SHASKAR24, Investors psychology A study of

Investor Behaviour in the Indian Capital Market. In the chaos of the Indian stock

markets lies the key to its biggest mystery. Stock markets world over display

tremendous uncertainty, volatility and unpredictability. Rooted as the valuation of

stocks may be in their own fundamental strength, their value in the ultimate analysis

is determined by market participants. This study intends to provide an insight into

the workings of an investors mind. It examines various aspects of individual and

mass psychology. It identifies factors behind valuation fundamental mismatch. In a

market like India, where the quest for transparency and efficiency is still on, various

intriguing, valuation discordance form the highlights of the study. It also seeks the

views of various market participants and incorporates them into the study; the study

23
David Hirshleifer, Investor Psychology and Asset, The Journal of finance, Volume 56: Issue 4, August
2001, pp 1533-1597.

24
S. Balaji Iyer and R Kumar Shaskar, Investors Psychology A study of Investor Behaviour in the Indian
Capital Market. Vol XVI no 4, December 2002, p 1357.
 49

identifies the whole gamut of investors psychology and the resultant behaviour in

stock markets in general, with particular reference to India.

G. ARUN & J.D. TURNER25, Financial Sector Reforms in Developing Countries: The

Indian Experience: This study is based on the premise that the success/failure of

financial sector reforms depends heavily on country specific factors and makes an

attempt to examine these factors in the Indian context. The financial sector reforms

analysed in this paper include the deregulation of interest rates, increasing

competition and foreign ownership and the introduction of financial supervision. The

authors argue that an economic rationale for a gradualist approach to financial

reform is that it is stability enhancing. Furthermore, they suggest that Indias

complex political economy has resulted in a gradual approach to reform and this

approach has been successful along the dimension of banking stability.

R. GASTON GELOS and SHANG-JIN WEI26, in the article entitled, Transparency

and International Investor Behavior, Does country transparency affect international

portfolio investment? The authors examine this and related questions using some

new measures of transparency and a unique micro dataset on international portfolio

holdings. They distinguish between government and corporate transparency. There

25
T.G Arun & J.D. Turner, Financial Sector Reforms in Developing Countries: The Indian Experience The
World Economy, March 2002, Volume 25 Page 429.

26
R. Gaston Gelos and Shang-Jin Wei, Transparency and International Investor Behavior, NBER Working
Paper No.9620, Issued in October 2002.
 50

is clear evidence that international funds invest systematically less in less

transparent countries. On the other hand, hedging among funds tends to be more

prevalent in less transparent countries. There is also some evidence that during

crises, funds flee non-transparent countries by a greater amount.

SHLOMO BENARTZI and RICHARD H. THALER27, How Much Is Investor

Autonomy Worth? It was stated that, there is a worldwide trend towards defined

contribution savings plans, where investors are often able to select their own

portfolios. How much is this freedom of choice worth? We present retirement

investors with information about the distribution of outcomes they could expect to

obtain from the portfolios they picked for themselves, and the same information for

the median portfolio selected by their peers. A majority of the survey participants

actually prefer the median portfolio to the one they picked for themselves. The

authors investigate various explanations for these findings and offer some evidence

that the results are partly attributable to the fact that investors do not have well-

defined preferences.

MANI SHANKAR AIYAR28, Stock Market Scam and UTI imbroglio JPC Report X-

Rayed: The issues dealt with, in the report of the Joint Parliamentary Committee

27
Shlomo Benartzi and Richard H. Thaler, How much is Investor Autonomy worth, Journal of Finance,
Volume 57: Issue 4, August 2002.

28
Mani Shankar Aiyar, Stock Market Scam and UTI imbroglio JPC Report X-Rayed, Economic and
Political Weekly, March 8, 2003, p-969.
 51

pertain to the persistent and pervasive failure of the key regulators to perform their

duties and the failure of the governance pertaining to the failure of the Ministry of

Finance to perform its duties. They also include the failings of the departments of

government and a regulator, as well as of the investigative agencies (CBI,

Enforcement Directorate, etc.) which fall directly under the Prime minister.

The seminar on Expanding Access to the securities market for the rural and un-

banked areas. The development of the Indian securities market, the benefits of

engaging in securities market and the recent initiatives of the government and apex

institutions was traced. Using this background, the presentation outlined a twin-fold

approach- regulatory and operational to address the issue of access and the need

to identify organisations who can facilitate and enable the development of new set of

investors.

PAUL BROCKMAN and DENNIS Y. CHUNG29, in their article entitled, Investor

Protection and Firm Liquidity: The purpose of this study is to investigate the relation

between investor protection and firm liquidity. It is concluded that less protective

environments lead to wider bid ask spreads and thinner depths because they fail to

minimise information asymmetries. The Hong Kong equity market provides a unique

opportunity to compare liquidity costs across distinct investor protection

environments, but still within a common trading mechanism and currency. The

29
Paul Brockman and Dennis Y. Chung, Investor Protection and Firm Liquidity, Journal of Finance ,
Volume 58: Issue 2, April 2003, pp 584-596.
 52

empirical findings verify that firm liquidity is significantly affected by investor

protection. Regression and matched-sample results show that Hong Kong based

equities exhibit narrower spreads and thicker depths than their China based

counterparts.

SANJAY K HANSDA and PARTHA RAY30, Stock Market Integration and Dually

Listed Stocks Indian ADR and Domestic Stock Prices. In search of the micro

foundation of the commonly held view of a dominant NASDAQ and satellite Bombay

Stock Exchange (BSE), the study looks into the price interdependence, of 10 Indian

companies, which have floated American Depository Receipts (ADR). The strong

correlation between the prices of the dually listed stock is collaborated by the finding

of a bi-directional causality in a vector auto regression model. The competing

domestic stock exchange, i.e., National Stock Exchange (NSE) too is found to share

the same bi-directional relation scrip wise, with the Nasdaq New York Stock

Exchange. Furthermore, the impulse response pattern indicates that a positive

shock in the domestic (international) price of scrip gets transmitted in terms of a

strong positive movement in the international (domestic) price the very next day.

Thus, the quotes of both the market share not only stock wise bidirectional causality,

but markets also are efficient in processing and incorporating the pricing information.

30
Sanjay K Hansda, partha Ray, Stock market Integration and Dually Listed Stocks Indian ADR and
Domestic Stocks Prices, Economic and Political Weekly, Feb22, 2003, p-741.
 53

JAN DU31, Financial Integration for Indian Stock Market, A Fractional Co-integration

Approach, noted that the Indian stock market is one of the earliest in Asia being in

operation since 1875, but remained largely outside the global integration process

until the late 1980s. This paper empirically investigates the long run equilibrium

relationship and short run dynamic linkage between the Indian stock market and the

short dynamic linkage between the Indian stock market and the stock markets in

major developed countries after 1990 by examining the Granger Causality

relationship and the pair wise, multiple and fractional co-integrations between the

Indian experience, and draws some policy conclusions regarding the role of such

flows. It also addresses the issue of volatility in the Indian context. It finds that there

is no coherent macroeconomic model behind the expert groups analysis and

recommendations; no appraisal either of the optimal scale of capital inflows or the

relative merit of FII vis--vis other categories of capital receipts at the current

juncture of the economy and no examination of monetary/fiscal problems associated

with FII or of the quantitative impact of such flows on and other macro variables.

PRIYA BASU32, Indias Financial Sector: Recent Reforms, Future Challenges,

assesses progress with financial sector reforms over the past decade in India and

analyses the new challenges that confront Indias policymakers and financial

regulators with regards to sustainability of growth and poverty reduction, highlights

an extensive reform agenda pointing for the need for a progressive reduction in fiscal

31
Jan du, Financial Integration for Indian Stock Market, Finance India Vol XVIII N4 Dec.2004, p1581.

32
Priya Basu, Indias Financial Sector, Recent Reforms, Future Challenges, Macmillan, 2005.
 54

deficits, further developing capital markets and improving access to finance for the

underserved.

TOMAS DVORAK33, in his article entitled, Do Domestic Investors Have an

Information Advantage? Evidence from Indonesia, Using transaction data from

Indonesia, shows that domestic investors have higher profits than foreign investors.

In addition, clients of global brokerages have higher long-term and smaller medium

(intra month) and short (intraday) term profits than clients of local brokerages. This

suggests that clients of local brokerages have a short-lived information advantage,

but that clients of global brokerages are better at picking long-term winners. Finally,

domestic clients of global brokerages have higher profits than foreign clients of

global brokerages, suggesting that the combination of local information and global

expertise leads to higher profits.

C.P CHANDRASHEKAR and PRATHPRATIM PAL (2006)34 in Financial

Liberalisation in India noted that, the Indian experience with reforms in the financial

sector indicates that, inter alia, these are important outcomes of such liberalisation.

First, there is increased financial fragility, which the irrational boom, in Indias stock

market, epitomises. Second, there is a deflationary macroeconomic stance, which

33
Tomas dvorak, Do domestic Investors Have an Information Advantage? Evidence from Indonesia, Journal
of Finance, Volume 60: Issue 2, April 2005, pp817-839.

34
C.P. Chandrashekar, Prathpratim Pal, (2006) Financial Liberalisation in India Economic and Political
Weekly, March 18, 2006, p 975.
 55

adversely affects public capital formation and the objectives of promoting

employment and reducing the poverty. Finally, there is a credit squeeze for the

commodity producing sector and decline in credit delivery to rural India and small

scale industry. The belief that the financial deepening that results from liberalisation

would in myriad ways neutralise these effects has not been realised.

R.H. PATIL35 Current State of the Indian Capital Market, stated that, in the early

1990s, India figured low in the global ranking of the state of capital market. The

adoption of sophisticated IT tools in trading and settlement mechanisms has now

placed India in the lead. The National Stock Exchange has played an important role

in this transformation. Shorter settlement periods and dematerialisation have been

other major developments. But all is not entirely positive. The introduction of

individual stock further poses a major risk; so also the large inflow of funds through

participatory notes.

S. P. UMA RAO, DAN WARD, SUZANNE WARD (2007)36 studied that investors

may not fully take advantage of possible portfolio risk reduction and higher returns if

they exclude international mutual funds from their portfolio. In their study they stated

that performance can be evaluated with a simple, yet theoretically meaningful

measure that considers both average return and risk. During the study period,

35
R.H. Patil, Current State of the Indian Capital Market Economic and Political weekly, March, 2006 p1001.

36
S.P. Uma Rao, Dan Ward, Suzanne Ward (May 2007), Empirical Analysis of International Mutual Fund
Performance, International Business & Economic Research Journal, Volume 6, Number 5, PP.19-22.
 56

foreign mutual funds appear to have more volatility and higher risk but have

outperformed U.S. mutual funds in nominal and risk-adjusted terms. Predicting in

advance which mutual funds would outperform is difficult and the cost of selecting

the "wrong" mutual fund is very high. Investors have to keep in mind that sound

investment decision-making combines the science of quantitative analysis with the

art of qualitative judgment and reason.

SHANMUGAM R AND MUTHUSWAMY37 in an attempt to describe the investment

process of Indian investors concluded that the investment public in India drawn from

middle income group investors are divided into three groups namely tax savers,

traditionalists and risk takers. An attempt has been made to highlight the differences

in investors preference over various investment parameters. Apart from giving

importance to regional industry in personal portfolio, occupation of investors was

found to be having an impact on investment decision.

DEMISSEW DIRO EJARA, RAJA NAG38 (2009) studied that managerial tenure has

positive impact on mutual fund performance. The impact on three and five year

annualized returns is statistically significant. The impact on ten year annualized

return is positive but statistically insignificant. This implies that while experience and

37
Shanmugam R and Muthuswamy P Decision process of individual investors in Indian Capital Market, UTI
Institute of Capital Market pp.62-71.

38
Demissew Diro Ejara, Raja Nag (May 2009), Managerial Tenure and Mutual Fund Performance: Evidence
from Index Funds, Journal of Business & Economics Research, Volume 7, Number 5, pp.103-111.
 57

the ability to plan on longer term basis helps managers increase returns, the

influence of such tenure decreases when we consider very long time horizons.
 58

Section II

Section II deals with studies relating to midcap funds.

DONALD BISSON (2005)39 noted that it is important to remember that the fund's

investment objective is nonfundamental and may be subject to change. Mid-cap

securities may be subject to special risks associated with narrower product lines and

limited financial resources than compared to their large-cap counterparts and, as a

result, mid-cap securities may decline significantly in market downturns. Smaller

capitalization stock investing may offer the potential for greater long-term results;

however, it is also generally associated with greater price volatility due to the higher

risk of failure. An investor should consider the fund's investment objectives, risks,

charges and expenses carefully before investing or sending money.

ASHISH CHUGH (2006)40, Investment Analyst said Investment in Small and Mid cap

stocks has its advantages, however the risks associated with investing in such

stocks should also be understood by investors before they take a plunge into buying

these stocks. The benefits are the most successful companies today started as small

companies. The fact is that when Infosys came out with its IPO at Rs.95 in 1994,

there were hardly any takers and the issue devolved on the underwriters. The market

39
Donald Bisson, Business wire, October 12, 2005.

40
Ashish chugh (2006), Are there trends towards small and midcap stocks, The ICFAI Journal of Applied
Finance, vol.13, No.2, pp.62-73
 59

capitalisation of Infosys was just under Rs.350 million when the company came with

the IPO, the company today commands a market cap close to Rs.800 billion.

NILANJAN DEY (2007)41 said, mid-cap funds are trying to claw their way back after

a spell of relative inactivity, spurred by the view that the market is consolidating and

valuations are again turning attractive. Some of them are aiming to utilise the large

cash positions they have been sitting on for some time. Fund houses, which suggest

that a range of mid-cap stocks is currently available at compelling prices, say that a

number of these are worth investing in at the moment. As a result, fund managers

are preparing for fresh allocations in the mid-cap space. The segment has been in

the news lately, mainly due to the volatility that has been evident there.

SANDIP SABHARWAL42, CIO (Equity), JM MF, said the mid-caps space holds

strong promise at this juncture. "The market has taken note of the consolidation that

has happened in this segment. There is a strong case for these stocks and investors

need to actively explore opportunities."

41
Nilanjan Dey, 20th March 2007, Business line

42
Sandip Sabharwal, 12th April 2007, Business line
 60

NILANJAN DEY43 noted that the sudden rush of private equity investment into small-

and medium-sized companies has caught the attention of mid-cap funds that seek to

create good portfolios, a relative absence of liquidity notwithstanding. With more

launches in the offing, these funds look up to PE investors, many of whom are

expected to unlock value sooner than later. With so many PE deals dotting the

country's investment landscape in recent times, fund houses believe the flow of initial

offers will be far stronger in the days ahead. A section of the small- and mid-sized

companies that the PE specialists have targeted will have to tap the market. The

emerging scenario, therefore, will be positive for mid-cap funds, for which the

investment universe is likely to widen. This is seen as very significant, given the

apparent shortage of good stocks in the mid-cap space.

NAVNEET MUNOT44said that the recent escalation in PE-related activity is a boon of

sorts for the asset management industry. The latter has spawned a number of small-

and mid-cap funds in recent days and more are probably in the offing. A number of

deals have already gone through, some of them brought about by well-known PE

funds. A section of the companies concerned are bound to come to the market

before long. Mid-cap funds are often constrained by several factors, say those in

investment circles. Liquidity (or, truly speaking, the absence of it) of the stocks they

43
Nilanjan dey, 24th March2007, Busines line

44
Navneet Munot, 12thApril 2007, Business line
 61

are supposed to target becomes a major issue. Some of these stocks are also said

to be under-researched.

JAYESH SHROFF (2007)45 noted that the front runners have always stolen the

limelight, the midcaps and the smallcaps which deserve a thumbs-up for staging

such a commendable performance. Midcaps posted a topline growth of 38 percent,

which is substantially high compared to Q4FY06 when the topline grew only 21

percent. Further the net margins also improved by 293 basis points on the back of

decline in interest and depreciation cost as a % of sales. This helped the midcaps to

post a bottom-line growth of 106.53%.

SANDIP SABHARWAL46, CIO of JM Financial AMC feels, Midcaps will outperform

large caps by a margin of 25-30 per cent over the next two years and as such

provide strong investment opportunities. There seems to be a large gap in the

valuations of smallcaps, midcaps and large-caps and hence it is an opportunity for

investors to accumulate this at cheaper valuations. There are many good quality

midcaps going at a single digit price earning ratio. Wherever the investor is confident

of the management, they should buy the stock.

45
Jayesh shroff, Midcaps a commendable performance, Dalal Street, May 14, 2007, Vol XXII. No.11,p.no.71

46
Sandip sabharwal, Midcap funds an opportunity for investors, Dalal Street, May 14, 2007, Vol
XXII.No.11,p.no-83
 62

NIKUNJ DOSHI47 noted that, looking at the huge opportunity that mid and small

caps have, the story in these would be more stock specific and would call for bottom

up approach. The focus should be on counters that could give good upside potential

with sound business model and good revenue visibility. On the fundamentals front,

most of midcaps and smallcaps have delivered superior results and expectations for

FY08 are still robust. The very fact that midcaps have underperformed makes them

more attractive, but we feel that if any rally to occur in the midcaps, it would be more

of a stock specific one.

SIDDARTH BHAMRE (2007)48 said our markets are continuing to dance on global

cues and off late we are following more European markets like FTSE 100 Index,

CAC 40 Index and others. Also, Rupee-Dollar movement is throwing good cues.

Market and Rupee-Dollar equation are inversely proportional to each other. The

quantum of short built up in mid-cap counters appears to be less than front liners.

This indicates that for coming trading session one should follow a stock specific

approach and should prefer to trade in mid-cap.

47
Nikunj Doshi,,Go with the current,Dalal Street, May14,2007, Vol XXII. No.11, p.no-96

48
Siddarth Bhamre, Market to remain submissive, Dalal Street, June 11, 2007, Vol XXII.No.13, p.no-36.
 63

NIKUNJ DOSHI49 noted that the current boom in the Indian economy looks set to

continue over the long term despite worries over political instability, rupee

appreciation and increased interest rate. Its good time for investors to pick up mid

caps, but without glossing over large caps. As for the stock picking strategy, Nikunj

Doshi believes in the BMV model, that is, Business, Management and Valuation. The

business model should be scalable and should be internationally competitive. The

management model must incorporate future growth aspirations. He added that the

valuation model must include financial analytical tools like return on equity, cash flow

analysis, DCF and NPV valuation. The investors should believe in the long term

growth story of the Indian economy. View every correction as an opportunity to

invest in the market. Its prudent to always have allocations in large caps even as

mid caps are set to perform will in the coming year. The fact that mid caps tend to

be volatile should not be lost sight of. Investors must therefore safeguard their

overall investment portfolio by hedging it with investments in both mid-cap and large-

cap issues.

The website Personalfn.com50 contains information about mid cap funds have

turned out to be a popular avenue for investors. The sharp growth clocked by mid

cap funds has no doubt played its role in endearing them to investors. However,

49
Nikunj Doshi,Follow stock specific approach and trade in mid-cap,Dalal Street, July 23,2007,
Vol.XXII.No.16, p.no-30.

50
www.personalfn.com/money/2007
 64

since mid cap funds as an equity fund category, does not have enough funds with

established track records (over 3-5 years), selecting the right mid cap fund can be

quite a task. Mid cap funds are mandated to invest predominantly in the shares of

mid cap companies. Such companies are usually under-researched, thereby

providing an investment opportunity that is yet to be recognised by the market. Well-

managed mid cap companies offer higher growth potential and can clock above-

average returns over longer time frames (3-5 years). On the flipside, investment in

mid cap companies tend to be riskier. Being under-researched there may not be

critical information for an accurate evaluation of its prospects; in effect the fund

manager could make a wrong investment call impacting the fund's fortunes

adversely.

SUNIL DAMANIA (2008)51 observed that the mid-cap has suddenly become a craze

in the market. TV or in print media keeps saying that the mid-cap segment will do

well. The fact is, if large-cap takes a beating, it is unlikely that the mid-cap would do

well. There will be quite a few counters that may do well in the mid-cap space. If any

sector does well, then the entire pace-whether it is mid-cap or large-cap will do well.

He had stated very categorically that today one needs to adopt a stock-specific

approach rather than having a herd mentality. One needs to apply abundant caution

before entering counters hitting upper circuits, especially in the mid-cap and small-

cap space. Its said there is a cartel operating in the market which throws up all kinds

of rumours about mid-cap and small-cap stocks in the market. Retail investors have

51
Sunil Damania,Mid-cap funds will surge further, Dalal Street, Jan22,2008, Vol XXII.No.4, p.no-32.
 65

very little knowledge about mid-cap counters and many of the investors who put their

money in the mid cap stocks are not even aware about who the promoters are or

what kind of products the company manufactures. A few investors who are selling

their blue chip counters to ride the mid-cap wave.

I.V. SUBRAMANIAM52 noted that the small size and a lower base do not give any

substantial indication that the mid-cap space should perform well. Ultimately, it is the

valuation that matters. Even the warren Buffett way of selecting stocks also

suggests the same. He believes in the concept of investing from a business

perspective and emphasizes on price being a major factor in stock selection. In other

words, we can say, what to buy, and at what price, is of paramount importance.

Many market experts believe that mid-caps are available at a relatively lower

valuation as compared to the large-caps. This is because the price we pay

determines the rate of return. Many market experts believe that mid-caps are

available at a relatively lower valuation as compared to the large-caps. Mid-caps

have continued to put up superb financial performance and are thus available at a

lower P/Es.

The website Kotakmutual.com53 contains information that Indian economy is

expected to sustain its growth momentum in the coming years on the back of

52
I.V. Subramaniam, The Outlook for the banking sector was never negative, Dalal Street, Jan22, 2008, Vol
XXII.No.4,p.no-48.

53
www.kotakmutual.com/kmw
 66

growing consumption, demand for infrastructure and increasing trend towards

outsourcing. We expect Indian economy to be resilient against any shocks in the

global economy due to huge base of domestic consumption. Improving demographic

profile of the country and growing urbanization are likely growth drivers. In such an

environment we believe mid cap companies will have better growth opportunities as

compared to larger companies within the respective sectors. Overall we therefore

believe mid cap companies will outperform broader market over medium to long

term.

HITEN SAMPAT54 observed that smaller the size, faster the growth. An infant would

always grow at a faster rate than a 10-year-old. This natural phenomenon may be

applicable to the companies as well: small-caps and mid-caps are likely to grow

faster than large-caps. Mid-caps are basically stocks in a particular market

capitalization and cannot be generalised as a sector. For example, marico is

relatively much smaller in size than Hindustan Lever. It is a well-known fact that

India is a big market and there is enough scope for a smaller entity to grow faster

and acquire larger market share. In addition, the economy itself is growing at a

scorching pace of over 8 per cent, creating enough opportunities for other small but

well-managed companies to grow at a faster pace. Hence, not only Gujarat Ambuja

or Acc or Grasim that can grow in the cement space, even shree cement, Birla

corporation and several other small and mid-sized cement companies can also grow

54
Hiten Sampat,Growth driven by mid-cap funds Dalal Street, Jan 22, 2008, Vol.XXII.No.4,p.no26
 67

and can expand their market share. Todays such small and mid-size companies

can become large-size tomorrow.

CHANDER R (2008)55 found that the mid cap rally has excited the retail investor

enough to wonder if there is something in it for him as well. The good news is that an

equity investment based on sound fundamentals (or a sound investment approach in

the case of mid cap fund) bought with a long-term investment time-frame (at least 3-

5 years) stands a good chance of delivering value to the investor. Investors with

some appetite for risk must undoubtedly consider adding mid cap funds to their

existing mutual fund portfolio. Existing is the operative word over here. It means that

investors must have a portfolio to begin with, preferably with large cap diversified

equity funds forming a substantial chunk. It is all very well to invest in mid cap funds,

but they should not be your frontline mutual fund investment and they should not

have a disproportionately high weightage in your portfolio.

SETHURAM (2008)56 noted that mid-caps are better understood by the market on

account of strict disclosure norms and better corporate governance adopted by these

companies. Now mid-caps are not unknown and they are well-researched by the

professional investment institutions like mutual funds. Such mid-caps which are well

55
Chander R(2008), Investment Managers market timing abilities, IIMB Management Review, Vol.18,
No.4,p.no39

56
N. Sethuram, Good Corporate Governance, Dalal Street, Jan 22, 2008, VolXXII.No.4,p.no-63
 68

researched by investment institutions will have lesser risk. In simple words,

investors should look at mid-cap scrips in which mutual funds have taken exposure.

MEHRABOON IRANI (2008)57 noted that the valuation of a stock is a function of the

risks associated with the stock and the return that the company is expected to

generate in future. If we say a mid-cap is undervalued, then the valuation can be

justified with the kind of risks inherent in the stock. Market experts believe that the

mid-caps are relatively riskier. This is because mid-caps have lower ability to sustain

the growth. They may not be able to withstand the stiff competition all the time. In

mid-caps, there are a whole lot of scrips that can end up giving over 50 per cent

returns, irrespective of where the sensex would be. But stock selection would be a

very important task. Individual stocks which form part of the mid-cap index have the

potential to give much better returns than most of the large-caps.

SANDIP SABHARWAL (2008)58 said that he is positive on midcaps from the point of

view of valuation and growth and expect the segment to outperform large caps over

the medium to long term. Midcaps tend to underperform in times of uncertainty and

outperform when the scenario becomes more benign. The uncertain environment

has impacted the performance of midcaps and it will remain so in the near term. The

57
Mehraboon Irani,Shine comes off midcap valuation, Dalal Street, Jan 22, 2008, Vol.XXII.No.4, p.no-58

58
Sandip Sabharwal,Invest in midcaps, Dalal Street,May12,2008,Vol.XXIII.No.11,p.no-63
 69

valuations of midcaps and smallcaps are fairly attractive and it makes sense to

invest in these, as they have the potential to outperform large caps.

BETH PISKORA59 noted that mid-cap stocks are sitting pretty compared with their

larger counterparts. According to statistics compiled by Standard & Poor's Chief

Investment Strategist Sam Stovall, mid-caps are in the sweet spot for growth and

valuation. Based on earnings estimates by S&P equity analysts, mid-cap stocks

(those in the S&P MidCap 400 index) should post profit growth of 15.8% this year,

compared with an earnings growth estimate of only 7.9% for the S&P 500 index.

While the price-to-earnings ratio for the mid-cap index is slightly higher17.9 vs.

15.7 for the "500"the p-e-to-growth ratio is identical for both indexes at 1.3.

YAMAL VYAS (2008)60 said this period may be a very good time to take a fresh look

at midcaps. There are many small and midcap companies which have come out

with highly encouraging results but the market has not taken any note of the same

and that is the reason why there are today dozens of bar-gains. Such companies

have apparently overcome the economic adversities like rise in costs and increased

competition and in few cases, adverse movements in foreign exchange rates.

Investors would do well to look at all results carefully and watch the price movement.

Normally, when a mid-cap company declares good results its counter witnesses

59
Beth Piskora, The Business Week, June 5, 2008.

60
Yamal Vyas,Catch the catch, Dalal Street, June 9, 2008, Vol.XXIII.No.13, p.no.47
 70

hectic trading for a few days. Thereafter, the movement drops and the price also

starts falling. This is the time when a good look at such a stock is warranted.

RAVISHANKAR PANDA (2008)61 said Mid Cap companies are often known as the

next Blue Chip companies. The mid-cap segment of the stock market is, thus, being

increasingly perceived as an attractive investment segment with high growth

potential. The determination to win, the craving to succeed and the urge to reach to

the full potential are the keys that unlock the doors to excellence for Indian

companies. Most of the CEOs confirm that success is not measured by the

accomplishment but by the risks and challenges encountered to achieve the

success. To reach a greater height a company needs to have fundamentally great

depth. Responsible management is a powerful way to grow a company. CEOs must

learn to how to carve success from failures. It is not what happens to us, it is what

we choose to do about what happens that makes the difference in how our lives turn

out. Leadership is the challenge to be something more than average. To understand

the growth potential of a company, look not only at what the company has already

achieved, but also at what it aspires to. Where the willingness is great, the difficulties

cannot be great. A true company is motivated by the desire to achieve, not by the

desire to beat others. Competition is a by-product of productive work, not its goal.

Most of the Mid Cap fund managers and analysts feel that Mid Cap companies could

under perform in the short term but eventually the fundamentally strong companies

likely to deliver a superior performance in the long-term and grow into a blue chip

61
Ravishankar Panda,Going will remain good, Dalal street, June 9,2008,Vol.XXIII.No.13,p.no.40
 71

company. With Indian economy growing consistently around 9 per cent we will see

more and more of these companies graduating to Large Cap companies. All they

need is a long term protean vision and hunger to perform globally.

B.VENKATESH (2008)62 observed that constructing a portfolio of mutual funds is not

an easy exercise. It is important to diversify the portfolio so that a retail investor has

exposure to the broad market. Yet, the portfolio should be small for ease of

monitoring. Portfolio managers generate alpha returns either through security

selection and/or market timing. Generating alpha in such cases requires good

tactical asset allocation skills such as shifting between large-caps and mid-caps. It is

moot if funds can beat the broad market index such as S&P CNX 500. Moreover,

buying a multi-style active fund as part of the core portfolio and a sector fund or

single-style fund for the satellite portfolio may result in over-exposure to a market

sector. An optimal choice would be to allocate the portfolio to mid-caps, bond funds

and emerging market funds. Investors would do well to pick active mid-cap funds.

The reason is that the mid-cap index constitutes 200 stocks, allowing more room for

the portfolio managers to engage in security selection to generate alpha returns.

Some mid-cap funds also take exposure to small-caps, which provide greater market

width. Care should be taken to choose mid-cap funds that have consistent track

record in generating alpha returns.

62
B.Venkatesh, Business Line, Aug 17, 2008.
 72

STOVALL63 noted that mid-cap stocks have less exposure to subprime mortgages,

and many of them are initiating or adding to dividendseven as some large-cap

stocks cut their dividend payments. The best way for investors to identify attractive

mid-cap dividend stocks is to use S&P's Stock Appreciation Ranking System, or

STARS. Stocks with those designations are expected by S&P equity analysts to

outperform the broader market on a total return basis during the next 12 months,

with the shares rising in price on an absolute basis.

SRIKALABHASHYAM (2008)64 noted that history has shown that when markets

tank, large-cap stocks come under selling pressure but in the case of mid-cap

stocks, selling is probably a gentle adjective. Mid-caps funds are ideal for those who

have the patience and have a good risk appetite. Risk taking ability is a greater

necessity than term because mid-cap funds can be highly volatile and may take

away a good chunk of the capital in the short term when market sentiment is weak.

However, same funds have the potential to offer above average returns when

markets stage a comeback, which has become a pattern in the last decade.

The website www.themoneyalert.com65 contains information that mid cap stocks

offer a mix of the potential growth of a small cap and some of the stability of a large

63
Stovall, The Business Week, June 5, 2008.

64
Srikalabhashyam, Bangalore Mirror, September 3, 2008

65
www.themoneyalert.com/middleoftheroadarticle
 73

cap, which could be a welcome addition to the portfolio. Mid cap stocks have

become a popular investment of late because of the attractive qualities that many

investors see in them. Frequently the companies are primed for potential growth, at

the same time theyve already gone through some of the growing pains which small-

cap stocks have yet to experience. Experts say that by the time a company has

ventured through life as a small cap, theyre often better prepared to handle the

markets woes. Theyve also usually had a chance to put quality management in

place, and better refine their product and their message. Thus, room for growth, but

with less growing pains.

CHANG E C AND LEWELLEN W G (2008)66 noted that information that mid cap is

only a stage in the life of a company it is not a business model or a deliberate

choice of the people running the company. Therefore the basic principles of running

a mid cap fund are very similar to those of diversified fund investing diversify

across sectors, find companies that have a good management and business model

and then invest in them for the long term; trade to book profits when the opportunity

arises; get out of stocks where the business model or the management does not

seem to be living up to its promise.

The website www.associated.com67 contains information that mid cap funds make

a happy medium in the realm of investing ideas because they grow at a faster rate

66
Chang E C and Lewellen W G (2008), Market Timing and Midcap Fund Investment Performance, Journal
of Business, Vol.57, No.1, pp.57-72.

67
www.associated.com/article
 74

than large cap funds, but carry lower risk than small cap funds. While all investing

carries risk, some carries more than other. Large cap funds are relatively safe, as

fund investing goes, but as a result, the returns are lower. Whenever investors risk

more, there are more chances for greater return. So small cap funds offer the best

chance of return, but the risk can be quite high. Mid cap funds present the middle of

the road view. Most mid cap funds average around 11 percent returns, and they

feature a risk level that most people can tolerate. Mid cap funds can be a great way

for the investor to diversify your investment portfolio. They allow investor to avoid the

hits taken when one particular sector of the stock market falls. Additionally, they are

great additions to investors retirement account, as they can help to save at a fairly

high rate, while at the same time balancing the risk.

VENUS K S AND SYED A (2008)68 noted that mid-cap funds are the haute couture

of the mutual fund industry. With the BSE midcap index giving an annualised return

of 39.41 per cent in the past three years, the Sensex returns of 34.15 per cent pale

in comparison. Mid-caps finally have their place in the sun with virtually every mutual

fund house having a dedicated fund in its stable. Mid-caps tend to combine the

characteristics of large-caps and small-caps by offering more growth than the former

and less risk than the latter. They score over small-caps by being more established,

financially more resilient and more liquid.

68
Venus k s and syed(2008), Aggregate Mutual Fund Flows and Returns, The Icfai Journal of Applied
Finance, Vol.15, No.1, pp.56-68.
 75

MARK PRESKETT69 noted that mid-cap funds have dominated the UK all

Companies space over three years with six out of the top ten in the sector investing

solely in FTSE 250 firms. Overall, the best performer to the end of March 2007 was

Ashton Bradbury's Old Mutual UK Select Mid Cap, which was up 113.19% on a bid-

to-bid basis according to Morningstar. Second was Paul Spencer's Rensburg UK Mid

Cap Growth, which generated 112.89% over the same timeframe. Mid-cap funds

from Schroders, Allianz, Aberdeen and HSBC also featured in the top ten, delivering

90% plus returns.

BADHANI70 noted that the way to reduce the risk, after having identified a sound

mid cap investment is to always have a long investment time frame. As a reputed

fund manager observed equities are the least risky asset over the long-term and

the riskiest assets over the short-term. So if the investor have taken the mid cap

route to generate wealth be prepared for the long haul. This way investor will be

relatively unaffected by intermittent volatility because investor are clear that they

expect to remain invested for at least 5 years.

The website Money control.com71 contains information that there are suddenly

plenty of mid-cap funds and the investment case is more or less similar spotting

69
Mark Preskett,Anomalies or Illusions/ Evidence from Stock Markets, Journal of International Money and
Finance, Vol.13, No.1. p.no.104-116.

70
Badhani,The Behaviour of midcap funds, Financial Analyst, Vol.29, No.6,pp68-84

71
www.moneycontrol.com
 76

the big boys of tomorrow, today. Of course all investment is about future returns, but

the mid-cap case is particularly attractive, since the indices seem to support this

contention and unfortunately the indices act on investors like light to moths. If the

fund house has very strong research and is able to really spot strong opportunities in

a disciplined manner, the fund should be a great long term investment. The best

returns are always derived from spotting the opportunity early and holding on for 7-

10 years or more. These funds test the fund managers conviction. The fund gives an

opportunity to diversify across mid-caps as well as use some scientific method to

identify mid-cap stories, rather than the next hot tip from the neighbour.

UDIT PRASANNA MUKHERJI AND KRISHNENDU MUKHERJI (2009)72 observed

that Mid-cap funds which have been the fire flies in the past few months seems to be

taking a heavy beating as the markets enter the corrective zone. Almost the entire

mid cap fleet has witnessed a heavy erosion of corpus in last one month. In last one

month (as on November 4), only four out of top 25 mid cap funds have given positive

return while others are languishing in negative zone. This is in sharp contrast to the

last three months' compounded return where only one out of top 25 funds gave

negative returns. Experts feel that the sharp correction in mid cap space in the

market has led to the downfall. However, some of them opined that this could be the

right time to enter mid cap funds when their net asset value has eroded 10-15%.

According to data, some of the top funds that suffered major setback are, SBI

Magnum Midcap Fund (growth) with -8.9% return, JM Emerging Leaders (growth) -

72
Udit prasanna mukherji & Krishnendu mukherji, Times of India, November 17 2009.
 77

5.03%, Sundaram BNP Paribas Select Small Cap -4.8%, ING Mid Cap Fund

(growth) -4.2%, Principal PNB Long Term Equity -4.25% etc. Some of the mid cap

funds that managed to stay afloat are Birla Sun Life Mid Cap Fund 0.56%, HSBC

Mid Cap Equity 0.42%, Franklin India Smaller Companies Fund 0.05% etc. Director

of Plexus Management, a portfolio adviser, Prasunjit Mukherjee feels that the sharp

decline in the NAV of mid cap funds has opened up an opportunity for the investors.

"This is time to increase allocation to mid cap. In future they will give good returns.

The mid cap companies have greater flexibility in adverse conditions, similarly they

can perform better in the boom time," Another fund analyst said that there is no good

or bad times for investing in mid-caps. Funds with consistent track record should be

the apt choice of the investor. These funds are flavour of rising markets as they give

higher returns than growth stocks. The trend is just reverse during bearish phase as

they are dumped first. So, returns should not be the sole criteria for investing in such

funds."

CHANDER R73 noted that the Mid-cap funds should represent 12 to 25 per cent of a

long-term portfolio. Picking a good fund in this category is one of the toughest

exercises for an investor because few funds are solid long-term performers. When a

fund establishes a great track record, assets explode and the manager often cant

find enough good small companies to buy.

73
Chander R (2009), Market Timing and Midcap fund performane, Journal of Business, Vol.57, No.1,pp82-
93.
 78

S. HAMSINI AMRITHA74 observed that the investors are usually warned to stay from

mid and small-cap stocks in highly volatile markets, as they may be more vulnerable

to stock market declines. On days when markets fell sharply, the blue-chip names in

the Nifty and Sensex have usually lost more value than mid/small-caps. On days

when markets weakened sharply November 12 and November 18, the mid-cap

index actually registered a smaller fall than the sensex.

YAMAL VYAS75 noted that the year 2008 has been disastrous for all investors, and

the average investor portfolios have lost 60 per cent, give or take a few percentage

points. The fall in mid caps and small caps was, on an average, less sharp and less

severe than the fall in large caps. The major reason was the fact that the large caps

were in derivatives segments, where there is no circuit filter, while the small and mid

caps are generally allowed to fall or rise only 5% on a day.

THENMOZHI M AND THOMAS (2009)76 noted that Planning for retirement and how

to invest the money saved presents a wide choice of investment options. In the stock

market mid-cap stocks have been called "the forgotten asset class" and "the road to

wealth" in stock investing. Selecting mid-cap funds as a part of retirement planning

74
S.Hamsini Amritha, Nov 19, 2009, Business line.

75
Yamal Vyas(2009),Program Trading and Expiration Day Effects,Financial Analysts
Journal,Vol.43,No.2,pp.78-89

76
Thenmozhi M and Thomas, Stocked Returns and Weekend Effect, Journal of Finance, Vol.45, No.1, pp.23-
43.
 79

investments may provide extra gains to a retirement portfolio. Mid-cap funds are a

good choice for adding long term growth to investments. There are a large number of

choices in mutual funds and ETFs to invest in mid-cap stocks. Review the funds

stock holdings, management fees and return history before selecting any fund.

T. SRIKANTH BHAGAWAT77 observed that, The longer you stay invested, better

will be your gains. Instead of shifting funds continuously and incurring entry loads, it

is better to make a proper choice of funds in the beginning itself, and stay invested

till you need the money. A few observations on the choice of funds and he

suggested that the investment could be done of the following mid cap oriented funds

such JM Basic JM Contra, Sundaram Select Mid-cap and IDFC Premier equity.

KHYATI DHARAMSI78 noted that the adage that markets always go the way one

never predicts them to, seems to have been re-confirmed by the rally which began in

March 2009. At least 14 of the top 20 equity funds selected on the basis of six-month

performance belong to the mid, small and micro cap categories. The benchmark

indices belonging to the different categories also tell us the performance differential.

While BSE sensex gave 82% returns in the past six months up to September 4,

2009, BSE Midcap index delivered 116% and BSE Smallcap shot up by 129.28%

during the period.

77
T. Srikanth Bhagawat,Are seasonal anomalies real, Dalal Street, Jan 18, 2009, Vol.XXIII.No.02, p.no 81.

78
Khyati Dharamsi, DNA, September 07, 2009.
 80

The website dnaindia.com79 contains information about midcap funds that, During

the credit crisis there was a lack of credit availability for small and midcaps. It was

difficult to say whether they will be able to survive or not. But after the induction of

liquidity locally and globally by central banks, the small and mid caps survived. Risk

aversion trade is over. People are now looking at not just domestic consumption

driven stocks but also stocks benefiting from global recovery such as export related,

IT stocks.

SURESH PARTHASARATHY (2010)80 noted that funds that focussed on mid-cap

stocks have clocked impressive returns over a one-year period. The average return

for the mid-cap funds category was 101 per cent (as on April 19) against the 76 per

cent generated by the diversified peers. The mid-cap stocks barometer the CNX

Mid Cap generated 104 per cent, while the BSE Midcap index has delivered

generated 102 per cent against 56 per cent and 60 per cent generated by bellwether

indices CNX Nifty and BSE Sensex . Despite such a stellar performance both the

mid-cap indices were some way away from their all-time highs achieved in the early

part of 2008. The segment bore the brunt of the market meltdown. The return

divergence between mid-cap funds was however wide. The gap between the best in

the category and the worst was quite wide at 42 percentage points. Over a one-year

period, ICICI Pru Discovery, the fund that practices value investing, clocked 123 per

cent and topped the return chart, while JM Midcap has generated a return of 84 per

79
www.dnaindia.com/report

80
Suresh parthasarathy, Business line, April 28, 2010.
 81

cent and finished at the bottom of the mid-cap category. This was still better than the

diversified fund category average. Sector selection played a major role in the

performance. For instance, in March 2009, the top three preferred sectors of ICICI

Pru Discovery were pharma, banks and petroleum, while JM Mid Cap Fund invested

mainly in the auto sector. At the start of the market rally in 2009 several mid-cap

funds held higher cash position, and were slow to participate in the rally. For

instance, Magnum Global held cash and equivalents to the tune of 18 per cent, while

Birla Midcap held 14 per cent. But at the end of one-year period both the schemes

managed to beat the CNX Mid Cap Index by 8 and 12 percentage points through

quick deployment and stock selection. However for the same period, 10 out of the

21 mid-cap schemes failed to beat the CNX Midcap.

The website www.rupeetalk.com81 contains information that mutual funds with mid-

cap stocks have yielded huge return to investors in past year. However multi-cap

funds which arent limited to one sector have given even more returns than mid-cap

funds. According to the sources top multi-cap funds are much ahead in race when

compared to large-cap, mid-cap and tax-saver funds in three years and five years

return. If largecap funds have given 13.6% to 15.7% returns in three years then

multi-cap funds have given 17.6% to 18.5% growth during the same period. As for

the mid-cap fund it was 12.6% to 17.5% in three years. However carefully chosen

large and mid-cap stocks on its day can beat any other investment funds. With

multicap there are twin benefits of liquidity offered by large cap stocks and potentially

81
www.rupeetalk.com/news/stocks/multicapfund
 82

outperforming opportunity offered by mid-caps. The advantages with multi-cap fund

are that they offer best investment opportunity for average investors. Also the

investor does not need to focus much on timing the market for exit and the fund

manager gets flexibility. According to the sources four out of five top multi-cap funds

have yielded a kitty of over Rs 1 lakh for investors who has started systematic

investment plan (SIP) of Rs 1000 per month five years ago. As far as mid cap and

large cap funds are concerned only two leading funds have brought Rs 1 lakh for

investor through a similar SIP.

DHIRENDRA KUMAR (2010)82 noted that the year 2007 was one of the mid- and

small-caps. Mid-caps in particular played a major role in elevating the Sensex

beyond the majestic 20,000 mark. In 2007, the Sensex gained a tad over 47%, the

BSE Mid Cap index garnered returns worth almost 69% and the BSE Small Cap

index surged ahead by a whopping 93.6%. No doubt then that the year belonged to

the mid- and small-caps. The mid- and small-cap funds also benefited from this rally,

easily outperforming their larger peers. Reliance Growth benefited the most; it

witnessed a 100% increase in its AUM. Mid-cap stocks were raked up by fund

managers of equity-diversified funds as well. But are mid-cap funds really worth their

while? Lets analyse their category to answer this. Seventy-four funds had

maintained an average mid- and small-cap exposure of over 50% in the past year

(February 2007 - January 2008). Out of these 74, they selected 20 top rated funds

(5, 4, and 3 star). The average return of these funds was a little over 32%. Tapping

82
Dhirendra Kumar, January 4, 2010, Economic times.
 83

the hidden potential of mid-cap shares is not easy. These stocks tend to rise and fall

in very short spans of time. They may touch new heights and then within days,

tumble down without notice. The recent market correction clearly illustrates the risk

associated with mid-caps. When the markets started to decline on January 8, 2008,

it was the BSE Mid Cap and Small Cap indices that took the beating by losing 30.7

and 37.8% respectively, compared to Sensexs loss of 23.5% (January 8 - March 7,

2008). Mid-cap funds lost heavily too. Sundaram Select Midcap had returned

63.14% in 2007 but the fund has lost over 30% in a short span (January 1 - March 7,

2008). Investing in mid-caps is hence an ideal option only for long-term investors.

And by long term, we mean at least 5-7 years. Such a time frame would give

emerging companies enough time to establish themselves. Firstly, do not get

fascinated just by a funds return during the bull-run. Look closely at how the fund did

when the markets fell. And secondly, it is very important to see the overall

capitalisation tilt of your portfolio.

SRIVIDHYA SIVAKUMAR (2010)83 observed that a strong comeback but marred by

a wide divergence in performance may best describe the one-year scorecards of

mid-cap focussed funds. These funds, 24 in number, have put up an average return

of over 37 per cent in the last year, about 3 percentage points short of that managed

by CNX Midcap Index. Outstanding performance it may seem, coming as it does on

the back of a deep correction in mid-cap stocks in 2008, but not all those who

invested in mid-cap funds may be in a sweet spot. For one, the majority of mid-cap

83
Srividhya sivakumar, Business line, June 13, 2010.
 84

funds underperformed the category average as well as their benchmark during the

year. Despite the broad-based market rally through a good part of last year, only 10

of the 24 funds outperformed the CNX Midcap. The picture only gets worse when

performance is measured over a three-year period, with only eight funds (out of 23)

ahead of the index. While mid-cap funds clawed their way out of the 2008 market

abyss, their performance has been quite divergent. For instance, while ICICI Pru

Discovery Fund topped the charts with its 62 per cent return over the year, Magnum

Midcap Fund, in contrast, portrayed a rather frail picture, with its 10 per cent returns.

On the other hand ICICI Pru Discovery followed a value investing strategy, the next

in line, DSPBR Small and Midcap Fund sported an array of offbeat small and mid

cap stocks. In contrast, the underperformers continued to drag under the weight of a

slow start in the 2009 rally, or simply failed to spot the opportunities at the right time.

However, save for Taurus Discovery and Magnum Mid-cap, all other mid-cap funds

managed to beat the diversified funds category average by a decent margin. Funds

such as ICICI Pru, Kotak Midcap, and Fortis Future Leaders secured their positions

in the top ten, beating the CNX Midcap index over the year, they have

underperformed the index miserably over a three-year period. Magnum Midcap

Fund, which is at the bottom of the returns chart now, was among the top performers

just three years ago; HSBC Midcap Equity Fund, despite its respectable record,

failed to appreciate as much as some of its peers. In contrast, newer funds such as

IDFC Premier Equity, Principal Emerging Bluechip, and DSPBR Small and Midcap

Fund surprised positively. This not only drives home the importance of regularly

monitoring funds' performance, it also highlights how the list of top performers is

prone to changes across market cycles.

 85

KON S J84 observed that on reading and listening to the views of various stock

market pundits over the past few days the one opinion that stands out is that midcap

stocks are expected to do much better in 2010. The general idea seems to be that

now that large-cap stocks have done their bit, its time for mid-caps to march ahead.

A favourite phrase seems to be stock-specific. For mutual fund investors, the

obvious equivalent of an equity investor investing in stocks is to invest in funds that

specialise in mid-cap stocks. However, this is a risky business because the penalty

for choosing the wrong mid-cap fund is far higher than that of choosing the wrong

large-cap fund. When markets in general fall, large-cap funds that do poorly tend to

underperform large-cap indices like the Sensex and the Nifty by a few percentage

points. Mid-cap stocks that underperform tend to do so by huge margins. Theres

more. When the markets recover, large-cap funds always recover well. However,

badly-run mid-cap funds recover poorly and sometimes never recover. The reason is

clear that theres a lot more variation within mid-cap performance. There are always

a large number of mid-caps that are underperforming the general midcap or market

trend. Obviously, there is also a good number that are outperforming the trend, but

this variability is much higher than that in large caps. It is one of the basics of

investing in stocks that large companies are fundamentally different from smaller

companies. Many of the differences become especially important when there is a

decline, either in the general market, or in the specific company that youve invested

in. When things turn downwards, smaller companies share prices decline more than

those of large companies. Moreover, smaller companies shares are less liquid than

that of large companies. When you go to sell them, it is entirely possible that there is

84
Kon S J, Can midcap funds outguess the markets, Journal of Business, Vol.52, No.2, pp.263-288.
 86

no one willing to buy, or that they have a high impact cost, meaning that the very act

of offering for sale, even a modest quantity pushes the price down. Impact cost

works in both directions, meaning that its pretty easy to rig a price upwards and

create illusions. Even at the level of fundamentals, there are differences. A far larger

proportion of small companies go into a terminal decline, that is, things turn bad for

them and they never recover. Because few small companies are being intensively

researched, bad news can be kept well-hidden far more easily and for far longer.

Since optimism is built into the mental make-up of all investors, its easy to believe

that well all choose the right fund. However, that doesnt actually happen

sometimes. At the end of the day, selecting good mid-caps is a much harder task

than selecting good large-caps. Its more rewarding, but its harder. The relation

between some selected mid-caps doing well and mid-cap funds doing well are more

tenuous than in case of large-caps. Most well-run large-cap and multi-cap funds

have a sprinkling of mid-caps. Unless an investor knows exactly what hes doing, its

best to stick to those.