Citi's midcaps outperformed the index in last 1 year. Here's what it recommends in the space now

Citi's top picks in the midcap space have outperformed the midcap index by about 7 percent over the past one year, the brokerage firm said in a report. This holds significance as midcaps have underperformed in the last two years.

"The midcap index has underperformed the Sensex by more than 30 percent over the past two years," the report noted.

The report, however, said that despite the underperformance, the domestic flows have held up. "Domestic mutual fund AUM into mid and smallcap funds have continued to grow despite the negative returns," Citi said.

The June-September quarter has seen Rs 58-66 billion inflows into mid/smallcap focused funds.

Citi said that the valuation discount of midcaps versus large-caps is close to 10-year highs, which highlights the improved risk-reward and low expectations. Interestingly, this compares to the highest premium to large caps in 2017. "In two years, mid-cap sentiment seems to have gone from extreme optimism to huge pessimism," the report said.

Citi said one of the reasons to buy mid or small caps is the high return potential if one can pick a multi-bagger. However, it said, citing its analysis of the last 10 years' performance to see what the odds are, only 2 percent of small caps become large caps while 20 percent no longer exist.

These are Citi's top midcap picks: