Prime Recommendation: A nimble mid-cap fund well-poised for this market

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  • Aggressive mid-cap fund, taking above-average exposure to small-caps
  • Low portfolio churn with a buy-and-hold strategy that allows it to accumulate stocks and realise potential
  • Ability to contain downsides during corrections and beat the index on upsides
  • Superior risk-adjusted return compared to peers
  • Consistency in beating benchmark across timeframes

Over the past two weeks, we have been writing on the promise in the mid-cap and small-cap segment of the market and how the rally is starting to move beyond a handful of large stocks. While a quick recovery may be some way off, the steep 2-year correction in the mid-cap space offers good opportunities to begin accumulating mid-caps from a long-term perspective.

Kotak Emerging Equity features in our researched list of recommended funds –  Prime Funds – and is among the funds we listed in our 2020 equity strategy. Please read our equity outlook on why mid & small cap funds are good segments to enter now.

The fund is among the more aggressive in the mid-cap category, dipping into small-cap stocks more than peers. It, however, still keeps volatility and downsides in check. The fund’s returns are well above that of peers and its size, at Rs 5, 718 crore is still manageable to bag opportunities in small and mid-caps. Kotak Emerging is managed by Pankaj Tibrewal.

Suitability

Before getting into strategy and performance details, know that Kotak Emerging Equity (Kotak Emerging) is for the high risk-takers only. Conservative investors can stick to less aggressive options such as Franklin Prima or opt for more dynamic large-and-midcap funds instead.

Kotak Emerging fits 5-7 year and longer portfolios. It can be used as the only mid-cap exposure, or along with another mid-cap fund or an aggressive large-and-midcap fund depending on your investment amount. Cap overall mid-cap exposure to 30% of your portfolio, no matter how high a risk-taker you are.

Stands out among peers

Kotak Emerging’s average 3-year return over a 6-year period comes in 18.2%. The mid-cap category clocked an average 14.1% in the same period. Barring L&T Mid-cap, the fund beat every other mid-cap fund. The fund is a consistent performer too. It beat the category average all the time when rolling 3-year returns over a 6-year period and the Nifty Midcap 100 TRI 85% of the time. These figures are among the best in category.

Part of the driving force behind these higher returns is the fund’s small-cap exposure, which is usually higher than peers. In the past year, for instance, small-caps accounted for about 19% of Kotak Emerging’s portfolio. Peers such as Franklin India Prima, HDFC Mid-cap Opportunities, DSP Midcap, and Axis Midcap have far lower small-cap exposures of 3%-14%. Kotak Emerging additionally picks stocks from the lower end of the mid-cap spectrum; its portfolio for December 2019, for example, has about 38% in stocks with market capitalisations of less than Rs 15,000 crore.

This ups its risk profile. When we talk of risk, we mean the risk stemming from holding a relatively higher small-cap allocation. But as far as performance goes, Kotak Emerging has managed to keep in line with peers as far as volatility and downside protection goes. On the volatility front, it is only slightly more volatile than the category average, thanks in part to its low portfolio churn and buy-and-hold strategy. On downside, Kotak Emerging loses much lesser than the Nifty Midcap 150 TRI across different timeframes over the past five years, using downside capture ratio as a metric.

Typically, funds that do great on containing losses use this ability to maintain better returns and don’t always capture upsides well. Funds scoring during bull rides tend to drop faster. Kotak Emerging, though, has the rare combination of containing downsides and participating in upsides. Going by the upside capture ratio across timeframes, the fund gains more than the Nifty Midcap 150 in rising markets.

Buy and hold stock-picking

As with most mid-cap funds, Kotak Emerging keeps individual stock allocations limited and holds a large portfolio, in light of liquidity risks. It adopts a bottom-up approach to stock selection.

That said, its sector spread is wide, encompassing financials, consumer, industrials, metals, fertilisers, and chemicals. This wide spectrum and its ability to pick lesser-known names can keep it in good stead, especially when market recovery gets more broad-based and reacts to economic recovery. For instance, stocks such as Ratnamani Metals & Tubes, APL Apollo Tubes, Oberoi Realty, and Lux Industries don’t feature in a lot of fund portfolios. These have rallied sharply.

sector allocation

Kotak Emerging does not churn portfolio much; its portfolio turnover ratio is among the lowest in category. Kotak Emerging’s portfolio liquidity is reasonable as well; the average time to liquidate the entire portfolio has averaged less than 30 days. It both accumulates and exits stocks gradually over a period of months so as to keep impact costs low.

For instance, the fund added to M&M Financial Services over the course of nearly 3 years using both dips and rallies to adjust holdings, as it has with Amara Raja Batteries, Alkem Labs, SRF, PI Industries, Solar Industries, Ramco Cement, Jindal Steel, and so on. Many of these stocks have been strong gainers in the recent pick-up.

The fund’s long-term buy and hold approach, its presence across niche stocks and sectors, and its ability to consistently deliver above-average returns make it a good choice for long-term portfolios.

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Please note that any specific queries on any of our recommendations will be answered ONLY through email. If you are a subscriber, please mail contact@primeinvestor.in.  Only general queries or discussions will be answered through the comment section of the blog. For full details, please refer to this post – How to communicate with PrimeInvestor.

33 thoughts on “Prime Recommendation: A nimble mid-cap fund well-poised for this market”

  1. Hi,
    I’m a bit curious on why the performance analysis was confined to the past 6 years alone? That seems like too less a timeframe to draw inferences from 3 year rolling returns. Tibrewal seems to be managing this fund since 2010. Taking a longer term performance since 2007, all its peers seem to have done better (5yr rolling and 3 yr rolling).
    Is there some fundamental change in the process?

    1. Bhavana Acharya

      Hello sir,

      We look at different periods and years for performance when we’re analysing; we try to put only relevant and useful information when we write an analysis like this. Apart from this, going too far back in performance has the risk that performance becomes irrelevant as markets change and funds change. So if a fund is turning around, its past performance will be poor, but it will an opportunity missed – and vice versa. So we balance both when analysing.

      Thanks,
      Bhavana

      1. Madam,
        Thank you for the clarification. I suppose this is a turn around. You mentioned HDFC, DSP, Franklin in the analysis. All these seem to have beaten this fund quite well back in the past. Might have been clearer to weave your story around the turn around and why it lagged in the past. Nevertheless, thanks for the research and the article.

        1. Bhavana Acharya

          Hello sir,

          I’ve noted your point. Our aim was to explain the fund’s strategy, and performance against both market and the category in general, instead of focusing on a few funds alone or going too far back in the past. Need to also keep length in check 🙂

          Regards,
          Bhavana

  2. Nihar Gokhale

    Hi,

    Your equity outlook link appears to be broken as it is leading to a 404 page. Can you update the correct link?

    The 3 multicaps I have picked have a cumulative 30% midcap exposure. I am keen on adding a smallcap fund. My investment horizon is 30 years. There is a Kotak Smallcap Fund run by the same fund manager as this fund. Do you think this fund is a good substitute to Kotak Smallcap, and for my objective? Since you also say that this fund has a higher allocation to smallcaps and small midcaps.

  3. Kartheek Varanasi

    Hi Bhavana,
    I have few query’s, if possible do a post to cover all the similar questions many people has,
    1. AUM of this Kotak emerging is going rapidly, will it sustain the past performance
    2. is the fund dependent on Manager performance or the process of the fund house,what if Pankaj left the AMC
    3. why do we see the performance difference b/w the same manager with different funds because the same Pankaj maintains Kotak Hybrid equity & small cap, there the performance is not top.
    4. Any great fund manager not all his funds are top list except mirae or very few other cases.

    Thanks,
    kartheek.

    1. Bhavana Acharya

      Hello sir,

      1. AUM – yes, it is growing but it is not always a problem. As long as the fund picks the right stocks and is able to reasonably manage liquidity, it can continue to do well. Large AUMs also lend themselves to lower expenses. Please note that in any fund, and in the market iteslf, past return numbers won’t necessarily repeat. This article explains return expectations, how they will be different over the years, and how to set expectations. So Kotak Emerging can continue to beat the market/peers, but returns may not be the level it was in the past.

      2. Fund performance depends on both fund manager and process. Kotak AMC does have a process in place and a specific mandate for each of their funds. That said, fund manager exits are not automatically a negative as the new fund manager can continue to keep the fund’s performance up.

      3 and 4. Funds have different strategies, they invest in different segments, and they behave differently in each market. All funds of a fund house cannot be at the top every single time. Not just that, relative position also depends on what other funds in the category are doing at that time. Looking at the chart topper every time and going by that will be misleading as funds come and go. What is the best returns today may not be the best one tomorrow. So what is important is whether the fund has beaten its benchmark and beaten its peers – and it does not have to be at the top to do that, it needs to be above average. This is what we see when we pick funds to recommend, so that we’re not influenced by the return number itself or returns at a particular point in time, and instead see performance over different periods.

      Thanks,
      Bhavana

  4. Thanks. I really appreciate the effort you put on the research and guide the subscribers. The response you provided is sufficient as of now. I just wanted to double check as I do not prefer changing the funds frequently and as an normal investor we can only check the past performances and few other stuffs but can not differentiate the quality of funds if past performance looks similar.

  5. Can you help me to understand the qualitative or strategical differences of this fund and DSP midcap which is also highly rated in prime ratings. I was able to compare the performance parameters of these midcaps and DSP midcap looks similar to Kotak emerging performance wise but not sure on quality, portfolio etc.
    reason for asking is because I hold Franklin Prima and if i want to add one more midcap probably for same or different goal is kotak emerging will be better addition?

    1. Hello sir,

      I hope you appreciate that it would be hard to do a comparative fund review covering performance, strategy and quality in this section and on an individual basis. The reasons we prefer Kotak is explained in the post. Briefly, DSP Midcap is a bit more volatile, is an up-and-coming performer and has gone through periods of underperformance earlier which is among the reasons why we prefer the Kotak fund between the two at this point.

      Thanks,
      Bhavana

  6. Hi I would like to know once you firm up a fund and recommend here, based on the past experience, how long it takes to churn or replace the particular fund?

    1. Hello,

      It’s hard to really pin down a frequency with which we would change funds. Churn will not be frequent, since the manner in which we pick funds means that we’d look at longer-term consistent performers – this either ensures that we don’t pick funds with flashy, one-off returns or we don’t keep removing funds because they do badly in a particular market phase. Thematic funds may see higher churn, as may liquid funds.

      Thanks,
      Bhavana

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