ime and time again, there is one investment that catches investors' fancy. And this investment is touted as a surefire way to make a packet.

This time around, it is the mid-cap stocks that have taken centre stage. 

Investors have been looking at the wonderful promise of midcap gains and have gone into a frenzy of pouring money into these stocks and the funds that specialise in them.

The past year has seen the Nifty (stock index of the National Stock Exchange) post impressive gains of 42.60%.

But, these returns pale when compared with the dazzling 107% of the CNX Midcap 200 (index of mid-cap stocks).

However, wrapped inside this promise is a dangerous threat. Their recent gains notwithstanding, mid-cap stocks are a far riskier bet than large caps.

• Is investing in blue-chips wise?

What are mid-caps?

If the number of shares in a company is multiplied by its current price, the result is market capitalisation. Based on this, companies are classified as large-cap, mid-cap and small-cap.

Blue chips are the largest companies in their sectors; the ones with the largest market cap.

If you can identify tomorrow's blue chips today, you could make a pile of money.

That's because these stocks, with smaller market caps, are usually priced low, since investors have not yet discovered their potential.

In the mid-cap segment, you may find such companies.

In fact, big investors, like mutual funds and Foreign Institutional Investors, have started investing in mid-caps in the recent past, because the price of large caps has increased substantially.

That has led to a big rally in small and mid-caps, with their prices climbing upwards steadily.

The mid-cap segment of the stock market is, thus, being increasingly perceived as an attractive investment segment with high growth potential.

However, there are certain things you must know about mid-cap stocks before you invest in them directly or via a mid-cap mutual fund.

• Why mid-caps are hot

High volatility

These stocks tend to be very volatile.

Volatility is the rate of change in the price of the shares over a given time. The greater the price fluctuation, the higher the volatility.

Historically, mid-cap stocks have displayed the tendency to rise more than large-caps in a booming market (like the one you are seeing now) and plunge to more depths when the markets dip.

While mid-caps may be going great guns at the moment, their historic record shows that they can fall like a pack of cards in bad times.

• 5 things you must know before buying shares

Liquidity constraints

Mid-cap stocks have a smaller capital base (number of shares) and suffer from low liquidity.

Liquidity refers to how easily the shares can be bought or sold in the market without significant loss of value.

Mid-cap funds have to then find quality mid-cap stocks to invest in. And, if they do not, then a chunk of their portfolio (total amount with them for investment) is left in idle cash.

If, however, they succeed in investing the entire portfolio in few mid-cap stocks by taking excessive exposure to each of them, then they might find it difficult to sell the holdings later, given the liquidity constraints.

• 5 rules when buying stocks

All mid-caps are not great buys

Mid-caps are characterised by lower market capitalisation and limited liquidity.

When such stocks witness a lot of buying, as they have in the recent past, their prices shoot up. Irrespective of whether or not their fundamentals are strong and in place or whether they are intrinsically sound companies. 

Picking up this rising trend, investors are pumping in more and more money into mid-cap stocks, further driving up the prices.

It has now turned into a vicious cycles or fresh money boosting up prices, which further attracts some more money.

• Invest in various funds, not one

Should you invest in a mid-cap fund?

If you have already invested in a diversified equity fund (fund that invest in the shares of various companies of various sectors), then you should know that even they have notably increased their exposure to mid-cap stocks.

So you are actually getting the mid-cap benefit even in a normal diversified equity fund

But, if you are willing to take the risk, then you could consider a mid-cap fund.

But do note, each fund house defines a mid-cap stock in a different way. Since there is no standardised definition of a mid-cap stock, each mutual fund will have its own. So what one fund house may consider a mid-cap, another may not.

It is undeniable that the spectacular performance of the mid-cap stocks has been nothing less than breath-taking.

You can make money. In fact lots of money. But how much you invest in mid-caps depends on how much of risk you are willing to take.

Remember, all mid-caps are not tomorrow's large-caps.

Illustration: Dominic Xavier