Five years is a reasonable time-frame for equity investments, but at the same time returns of small-cap stocks can be volatile. Would this five-year close-ended scheme deliver?

Axis Mutual Fund recently filed an offer document with the Securities and Exchange Board of India (SEBI) to launch a five-year close-ended equity scheme—Axis Small Cap Fund. This close-ended scheme will automatically convert into an open ended equity scheme on completion of five years from its launch. As these schemes invest predominantly in small-cap stocks it is necessary to be aware of the risks associated with such investments. In just two months, for the period ending 31 March 2013, the S&P BSE Small-cap Index crashed by nearly 19%. The index, which consists of over 500 scrips, saw nearly 25 stocks crash by over 50%. Five years is a reasonable time frame for equity investments, but returns of small-cap stocks can be volatile. In a way, being a close-ended scheme would be beneficial for an investor as he/she would not get tempted to withdraw the funds seeing a huge decline or volatility in returns which is common in small-cap schemes. But at the same time, a lot would depend on when and where the scheme would invest to ensure the investors gets decent returns at the end of the period.
 

As per the offer document, the scheme would invest a minimum of 70% in small-cap companies which are defined as those which have a market capitalisation within the highest market-cap stock (or Rs5,000 crore, whichever is higher) and lowest market-cap stock on the BSE Small-cap index. The range of capitalization of BSE Small-Cap Index will be reviewed on an annual basis. Up to 30% of the assets would be invested in other equities, debt and money market instruments. As we have seen in the past, small- and mid-cap schemes use this allocation to their benefit and invest in large-cap stocks to reduce the downside risk. (Read: Small- and Mid-cap schemes: Cushioning the fall)
 

As per our analysis, only a few schemes where able to reduce their downside risk and still come up among the top performers when there is a sharp upmove. But to pick such schemes, a prior track record of performance is required. This being a new scheme from Axis Mutual Fund, it has no track record and could be risky. The fund house itself has been in existence for less than five years. The only two equity schemes from the fund house, which have a track record of above three years, are Axis Equity Fund and Axis Long Term Equity Fund. Both the schemes have done reasonably well compared to the benchmark.
 

The new scheme would be managed by Pankaj Murarka, who has over 11 years of experience in the equity markets. Managing a close-ended scheme would be an easier task as compared to an open-ended scheme as the fund manager would not have to deal with new inflows and outflows from the fund. However, when investing in small-cap stocks one needs to go deeper into the business and management of the company rather than relying only on the financials and valuations of the company.
 

This being a close-ended scheme, the units of the scheme cannot be redeemed by the unit holder directly with the fund until the maturity/ conversion date. Post maturity/ conversion date, scheme can be redeemed a) Physical units – with the fund, b) Demat unit – with the Depositor participants.

Other details of the scheme
 

Benchmark
 

BSE Small Cap
 

Minimum Application Amount
 

Rs5,000 and in multiples of Re1 thereafter
 

Expenses
 

Maximum total expense ratio (TER) permissible under Regulation 52(6)(c)(i) and (6)(a): Up to 2.50%
 

Additional expenses under regulation 52(6A)(c): Up to 0.20%
 

Additional expenses for gross new inflows from specified cities: Up to 0.30%.