Mid/small cap funds have undoubtedly emerged as the season's flavour and Kotak Emerging Equity Scheme (KEES) is yet another addition to this ever-burgeoning category. We had earlier witnessed a spate of mid cap fund new fund offers (NFOs) in the 2004-05 period. Similar schemes are being launched yet again; the only difference being that the present lot is largely of the close-ended variety. Seems like fund houses have finally woken up to the importance of close-ended funds and how they promote long-term investing, which should be treated as being pertinent in the context of equity investments. Perhaps the new guidelines initial issue expenses on close-ended NFOs have played a part in convincing fund houses about the importance of close-ended funds.
On the topic of mid/small cap companies, typically, such companies tend to be under-researched ones, thereby providing an investment opportunity that is yet to be identified by the market. Investments in such companies offer high growth potential and the opportunity to clock above-average returns over the long-term horizon.
On the flipside, since mid/small-sized companies are often under-researched, there is a fair chance that some reasons for "not investing" could be overlooked. As risk control measures and corporate governance tend to be neglected, the chance of manipulation in such companies is higher. Similarly, the possibility of stocks remaining illiquid even at the end of the investment horizon does exist; this in turn can be an unviable proposition for the fund manager.
On account of restricted cash inflows and outflows, the fund manager of a close-ended fund can adopt a "buy and hold" strategy and make investments from a long-term perspective. This can prove handy, since mid/small cap stocks can be very volatile investments over shorter time frames, however, they hold the potential to unlock value and deliver over longer time frames.
The mutual funds segment has funds like Franklin Prima (49.5% CAGR over 5-Yr) and Sundaram BNP Paribas Select Midcap (55.2% CAGR over 3-Yr) that invest in the mid/small cap segment. More importantly, these funds have proven track records over longer time frames to show for. In light of the same, we recommend that investors give KEES a miss and instead invest in the aforementioned funds.