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

  • 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.

Here’s a list of the top mid cap mutual funds.

Relevant Article : A Nifty MidCap Index Fund that challenges other midcap funds.

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

  1. 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

  2. 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.

  3. 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

  4. 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

  5. How is this compare to HDFC mid cap fund and if someone is holding Midcap and Prima fund in their portfolio . What is advise to them if they want to add another sip of 25K for 6-8 years timeframe

    1. Hello,

      Adding Kotak Emerging to the other two funds you mentioned is fine. However, ensure that you are not over-investing in mid-cap funds.

      Thanks,
      Bhavana

  6. Please advise on the exit strategy for non performing VALUE funds like quantum long term HDFC capital builder fund.

    1. Hello,

      I would like to refrain from commenting on specific funds that you hold nor which funds to switch into, in this forum and without knowing the rest of your portfolio. However, do note that value fund returns are poor primarily due to the value strategy itself not working in these markets. That’s because there has repeatedly been a lack of clarity on earnings growth for many value stocks; the economic growth slump, for example, has pushed back investment demand. Stocks with earnings visibility have steadily climbed higher, and become more expensive as well. Value strategies by nature will go through periods of underperformance because it involves buying cheap stocks and waiting for markets to re-rate them. Therefore, the time to exit is not when returns are poor, as long as the funds themselves are quality ones with the ability to otherwise get calls right. Our outlook, both for the year and post budget are here and here. This can tell you a little more about what to expect from markets and funds.

      Thanks,
      Bhavana

  7. Hi,
    This particular fund is not rated 5 stars according to your prime star ratings. Why is there a special coverage on this fund?

    1. Hello,

      Ratings are quantitative and based on past performance. Choosing a fund goes beyond what the numbers show, and into qualitative aspects like strategy, portfolio, risk involved, and so on. If you check our Prime Funds, you will see that not all of them are 5 star. We pick funds that have clarity in strategy, that can continue to do well, that offer differentiation and so on instead of just picking 5-star funds. You can read more about our selection process here: https://www.primeinvestor.in/2020/01/13/prime-funds-our-philosophy/

      When we cover any fund, it will be because there’s some feature or characteristic of the fund that sets it apart, present good investment opportunities, or can be additions to a portfolio. We may, for example, pick funds that could be 2-star or 3-star today but which could well deliver in the coming years due to some change in strategy or the market or turning around or similar reasons.

      Thanks,
      Bhavana

  8. Thanks for the article, and the insight. This seems to be a great platform please keep up the great work.

  9. Murali Krishnamurthy

    While most feel attracted to mid/smallcap funds, I am still unclear on how suitable are they for building wealth over a long period of time considering the volatility they bring in.

    Most good midcap funds have a range of 12-20% over 7-10 yr period of time (as seen in VR).
    But if one looks at the return grade of good large-midcap funds, it is around the same return grade with a lot more consistency (and less volatility).
    So why not use 1-2 good large-midcap funds as they already have minimum 35% midcap allocation.
    In fact this category of funds are turning out to be “real multicap” funds as most multicap funds have heavy large cap tilt.
    So with a good mix of largecap (for stability) and large-midcap (for better returns) funds one should cover all bases.

    Any thoughts?

    1. Hello Sir,

      True, you have a valid argument. Explaining the mid-cap/small-cap question can be done with a lot of data 🙂 Will consider doing so in a separate article. That said, briefly, mid-caps and small-caps have very high return potential. The big rallies and multi-baggers are found more here than in the large stocks. Though they fall, the rise more than makes up for it, and their presence can really lift portfolio returns. Multi-caps cannot make up for it, since very few are mid-cap dominant even in mid-cap rallies.

      As far as large-midcaps go, it is a new category. We don’t have enough history to see whether their lower volatility and shift into mid-caps at the right time help returns. Mid-caps and small-caps may yet beat them. But large-and-mid funds are very useful for conservative investors, and even moderate risk investors, for mid-cap exposure. Mid-cap propensity to fall is one of the reasons we give high weight to downside containment, when we’re looking at funds.

      Regards,
      Bhavana

      1. Kartheek Varanasi

        Hi Bhavana,
        I do have a same feeling as KrishnaMurthy pointed out, most multicaps are large cap biased,I feel large-midcap is very good category with less AUM, Please do an article on this & give your recommendations as well..

        Thanks,
        Kartheek.

        1. Bhavana Acharya

          Hello sir,

          Yes, we will do an analysis on the fund categories as we have had quite a few questions on this front.

          But as I explained in my reply to that comment, we don’t have long enough a history for large-midcap funds to understand how they shift allocations and what effect this has on their returns and volatility. Small and mid-cap funds could very well beat them in a mid-cap rally; it depends on how well each participates in a rally and how well each manage to contain downsides. AUM is not the main factor to be worried about, especially for funds that can invest in large-cap stocks.

          Yes, multicap funds are large-cap biased. This is the reason we have been recommending substituting large-cap funds with moderate-risk multicap funds in long-term portfolios – and additionally in the light of waning large-cap fund performance. Our Prime Funds recommended list is mostly made up of multicap funds, in the moderate-risk category.

          Regards,
          Bhavana

  10. Hi Bhavana, good article. I had started moving into this fund based on your equity outlook article. My instincts have been validated by this article 🙂

    One question – when you mention keep midcap exposure to 30%, do you mean the entire portfolio including debt? Or is it 30% of the equity portion?

    Regards,
    Anand

    1. Hi Anand,

      Thanks! It is 30% of the whole portfolio including debt, not 30% of the equity. The reason for not having more than 30% of a portfolio in mid-cap is that the volatility in mid-caps can really pull down portfolio returns in bad years. So, though upside is great, extreme portfolio volatility will not help in the long run. Lower portfolio volatility results in better returns over time.

      Note: I’ve edited this comment to make the point more clear, as a follow-up question had a doubt.

      Regards,
      Bhavana

      1. Hi Bhavana,

        I think 30 % mid cap of overall portfolio is more volatile than 30 % of equity. e.g if someone has 50% of each equity and debt if mid cap is 30 % of equity it will be 15 % of overall portfolio. Can you clarify i am missing something.
        Regards,
        Prakash

        1. Hi Prakash,

          Sorry, think I wasn’t clear in my comment. You aren’t missing anything. I was referring generally to the fact that more than 30% is not prudent. I didn’t mean that 30% of equity exposure is more than 30% of total portfolio. Apologies 🙂 I have edited my earlier comment to reflect this.

          Thanks,
          Bhavana

      2. resp madam,
        just wanted %age to be illustrated
        total portfolio 100/-
        equity 80/- , debt 20/-
        30% of 100 or 80
        regards
        umesh

        1. Hello sir,

          When we say mid-cap exposure should not be more than 30% of the portfolio, it is 30/100. It is not 30% of 80% (the equity allocation in your example). Hope this is clear now.

          Thanks,
          Bhavana

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