A Fund to Ride in a Recovery
In our newsletter last week (click here to read it), we mentioned that we would identify funds that may be well-placed to ride an economic recovery.
While we may not be near a recovery soon, most experts accept that we may be at the fag end of a downturn – be it in economic growth, peaking interest rates or corporate earnings.
If that be the case, some of the smaller companies that were hit by the downturn, but still managed to keep themselves well afloat in tough years, may be amongst the best placed to use a recovery to pole vault their fortunes.
One such fund that takes adequate exposure to companies in the small and mid-cap space and has exposure to sectors that could sail fast in an upturn is Franklin India Smaller Companies Fund. With a return of 24% compounded annually in the last five years, the fund’s performance is a good 8 percentage points higher than its benchmark CNX Midcap and 5 percentage points higher than the mid-cap fund category’s average returns.
While this fund has had periods of slack performance, a marked pick up as a result of a strategy of taking contrarian bets has delivered results in the last 2 years, thus inspiring confidence.
Franklin India Smaller Companies Fund is suitable only if you have a high risk appetite and if you are looking for some tactical exposure. As mentioned earlier, there could be no overnight recovery happening. Hence, exposure to this fund is best done through SIPs.
SIPs done over the next one year and then taking stock of performance, compared with peers before further exposure, may be a prudent approach.
Franklin India Smaller Companies takes exposure to stocks of companies that are much smaller compared with other regular mid-cap funds. Hence, the portfolio’s risk profile is much more enhanced than mid-cap funds such as IDFC Premier Equity or HDFC Mid-Cap Opportunities.
Franklin India Smaller Companies does not have a superior long track record, if measured on a risk-adjusted basis (sharpe ratio) over the last 3 years, especially when compared with top mid-cap performers. But the fund has reversed this performance in the last 2 years, generating returns superior to top quartile performers in the mid and small-cap space.
In the last 3 years, the fund beat its benchmark 94% of the times on a rolling one-year return basis (taken every single day in the 3-year period). While that is noteworthy performance, mid-cap funds such as Religare Invesco Mid N Small Cap have managed to beat the same benchmark 100% of the times, showing better consistency. But then, it is only expected of a much smaller-cap focused fund like Franklin India Smaller Companies to underperform its slightly larger-cap benchmark in prolonged downturns.
Franklin India Smaller Companies’ portfolio has stocks with an average market-cap of about Rs 3,700 crore. That’s less than the Rs 5,000-6,000 crore market cap average of most mid-cap focused fund portfolios.
This, together with the fact that the fund has exposure to sectors/stocks that are not at present held by too many funds, are key reasons for our choice of this fund; among the few we would like to pick, as one to ride the economic recovery.
If you thought sectors such as industrial products or capital goods were down and out, Franklin India Smaller Companies’ portfolio would prove otherwise. Stocks such as Finolex Cables, Supreme Industries and AIA Engineering were some of the dark horse picks that worked well for the fund in the past year.
Similarly, chemical plays such as Pidilite Industries or pesticide bets like PI Industries were all well timed picks. The fund’s top sectors of industrial products and, chemicals, besides the usual cyclical banking sector and auto ancillaries could benefit more when the economy moves decisively upward.
The contrarian bets are though sufficiently balanced with defensives by way of exposure to pharma and IT stocks. Individual stock exposure is capped at less than 5% to avoid getting stuck in small stocks. Also, a portfolio turnover of less than 30% implies that the fund goes with a buy-and-hold strategy for a good part; a strategy essential to building wealth with mid- and small-cap stocks.
The fund is managed by R Janakiraman and K N Sivasubramanian.