Investing In Small & Mid-Cap Funds

I had invested in Franklin India High Growth Companies Fund at the time of the FPO in the year 2007. Kindly suggest and advise me as to whether I should stay invested in the said mutual fund or switch to some other fund.

- Sanjay Kumar Agrawal, Varanasi

Franklin India High Growth Companies Fund is a small & midcap fund. The fund tries to generate returns by investing in high-growth companies.

On a long-run risk-adjusted return basis, the fund has not been among the top performers in its category. On a three-year basis, this fund was in the top quartile only eight per cent of the time (in terms of risk-adjusted returns). On a five-year basis, the risk adjusted returns were even worse – the fund was in the top quartile just five per cent of the time.

The following table illustrates the differences in the returns (compound annualized or CAGR) and downside risks (DSR) between Franklin India High Growth Companies Fund and other small & midcap funds. Downside risk measures the variability of returns that fall below the average or target expected return. Generally, a fund with a lower DSR will be less likely to underperform its peer group.

On a five-year basis, the fund only generated a CAGR of 1.50 per cent while its peers (like those shown in the table) generated returns that were nearly 10 times larger! On a three-year and five-year basis, the fund had a higher downside risk than its peers but failed to deliver high returns to justify its higher DSR.

Assuming that your investment in Franklin India High Growth Companies Fund is part of the small & midcap allocation in your portfolio, you could redeem your investments in this fund and invest in other small & midcap funds like HDFC Midcap Opportunities, ICICI Pru Discovery or IDFC Premier Equity. HDFC Midcap Opportunities and ICICI Pru Discovery focus on investing in undervalued stocks while IDFC Premier Equity focuses on growth stocks.

On an absolute basis, these funds have generated higher returns than Franklin India High Growth Companies as shown in the graph.

Additionally, in terms of risk-adjusted returns, HDFC Midcap Opportunities, ICICI Pru Discovery or IDFC Premier Equity have been more consistent performers as shown in the table below.[PAGE BREAK]

Keep in mind that unless you are a very aggressive investor, small & midcap funds should not take up more than 20 per cent of your portfolio. This is because small & midcap funds are volatile, and more so in turbulent markets. Within the small & midcap category, you could also look at Birla Sun Life Dividend Yield Plus, which is a relatively conservative and more stable small & midcap fund. The fund has low downside risk as in a falling market; it will effectively serve as a cushion in your portfolio. In contrast, HDFC Midcap Opportunities, IDFC Premier Equity & ICICI Pru Discovery are more aggressive funds with higher betas.

For additional safety, you may want to have some exposure to large-cap funds such as Franklin India Bluechip which aims to generate consistent growth through investments in well-established and large-cap companies.