Kotak Mutual Fund calls it Rising Star, Sundaram calls it Select Small Cap and ING Vysya calls it Competitive Upcoming Businesses. They have different names. But all these funds have the same objective: invest mainly in small-cap stocks.

How do they define it? Kotak wants to invest in mid-cap and small-cap companies, which had a market cap below Rs 5727 crore as on December 31.

Sundaram’s definition of small cap is any stock that is smaller than the 100th stock in the S&P CNX 500 Index, whether the stock is part of the S&P CNX 500 Index or not. This was about Rs 3700 crore at the time of writing. However, the benchmark for the fund is BSE Small Cap.

This is not small cap according to us. We have a five-tier definition of stocks by market cap. Our definition of small cap is stocks between Rs 100-Rs 500 crore, preceded by mid-cap (Rs 500- Rs 2000 crore) and followed by micro-cap (below Rs 100 crore). The funds are calling their schemes by different names but are targeting the same mid-cap space and lower end of the large cap space which they think will give them the best returns. This may turn out to be true but this strategy also carries the highest degree of risk. In the market carnage spanning May 10 and June 16, the BSE Mid-cap index fell 38% and BSE Small Cap fell 42% but the Sensex fell only 29%. The plans to launch a fresh round of mid-cap funds were drawn up before the recent carnage which shows how bullish the fund industry has been even in April and May at an index level of 12,000.

Meanwhile, the 10-year yield has pierced 8%. Investors must ask fund distibutors, if they can earn a risk-free income of 8%, why should they buy risky small caps and midcaps anymore? Expect funds to quickly react to this situation and launch a rash of “risk-free” debt funds.

Ascetic funds
Mutual funds were planning to raise thousands of crores when the Sensex shot beyond 10,000 earlier in the year and crossed 12,000 soon after. More than a dozen new fund prospectuses have been filed with SEBI but nobody has the courage to go ahead with those plans. But were there any fund houses that stayed away from picking up easy cash when the bull was running amock? Yes, there were. DSP Merrill Lynch and HDFC are the only two fund houses that did not come to raise money.

The others were greedy and ended up with funny timing. When the IPO market was red-hot, Stanchart planned a fund that would subscribe to the IPOs and sell them on listing. With a risky idea like this, the fund was extremely lucky to have raised oodles of cash just before the market crashed between May and June. It is sitting on almost that entire cash. Not only are there no IPOs to buy and flip but almost all the recent ones are under water (a possibility we had highlighted while suggesting you avoid this risky fund from Stanchart).