Another close-ended scheme investing in mid-cap stocks. What are the risks?
IDFC Mutual Fund plans to launch a five-year close-ended equity mutual fund scheme—IDFC League 1 Fund. The scheme would invest in equities and equity-related instruments of companies outside the top 300 companies by market-capitalisation. The scheme would invest 65%-100% in equities while the rest would be invested in debt and money market instruments. The performance of the scheme would be benchmarked to the BSE 500 index. Investing primarily in small- and mid-cap stocks, putting your money in this scheme with no exit route could be risky.
Recently Union KBC Mutual Fund filed its offer document to launch a unique close-ended equity scheme, Union KBC Trigger 50 Fund (Read:Union KBC Trigger 50 Fund: A Different approach, but is it worth the risk?). This was, however, just a three-year close-ended scheme. We had pointed out that three years is a short time to invest in equities as the markets can behave in a very erratic manner in a three-year time frame and worse still you could be withdrawing your investment at a loss. IDFC League 1 Fund has opted for a longer period, but still, withdrawing your investment at a predefined time can be risky.
Since this is a small- and mid-cap scheme, it is important to see how similar schemes have performed in the past. Over the last quarter ended September 2012, small- and mid-cap schemes were the best performers in terms of returns (Read: Moneylife, issue dated: 1 November 2012—Best Equity Funds in the September '12 quarter). These schemes normally do well during a market rally, but you should be aware of the downside risks as well. In FY09-10, when the Sensex grew by 70%, from 10,000 to 17,000, such schemes with a similar investment objective performed really well. Birla Sunlife Small and Midcap Fund gave a return of 141% and DSP BlackRock Small and Midcap Fund followed closely with a return of 139%. However, for the calendar year 2008 when the Sensex crashed to half its value, in the same period the CNX Midcap index fell by 59%. Funds like Birla Sun Life Small and Midcap Fund and DSP BlackRock Small and Midcap Fund fell by 61% and 58%, respectively.
Since the performance would be benchmarked to the BSE 500, how has the index performed in five-year periods? We calculated the five-year monthly rolling returns of the BSE 500 from January 2001 to October 2012. On an average, the index has returned 21.68% compounded annualised over the 94 periods. The minimum return has been 0.94% and the maximum return has gone up to 49.88%. In 71 five-year periods out of 94, the index has delivered a return greater than 10%. A lot depends when the investment was made. Had you invested in October 2007, at the end of five years your investment would have grown by just 0.94%.
The minimum investment amount that would be accepted would be Rs5,000. This being a close-ended scheme, facilities like Systematic Investment Plan, Systematic Transfer Plan and Systematic Withdrawal Plan are not available to investors and no redemption or switch out of units shall be allowed prior to the maturity of the scheme. Unit holders who wish to exit may do so through the stock exchange mode. The scheme would charge up to 2.70% of the daily average net assets as fees.