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Aarati Krishnan
Suresh Krishnamurthy

I do not foresee any issue in terms of not having enough stocks to invest in. The market will keep growing. You will find new stocks coming in. Mutual funds are not growing as fast as the market capitalisation. There is an opportunity there.

Mr Ajay Bagga

KOTAK Mahindra Mutual Fund recently launched its version of the mid-cap fund.

The focus of the fund is different in that it aims to beat Nifty Junior and not CNX Mid-cap 200. Business Line spoke to Mr Kenneth Andrade (KA), the fund manager of the mid-cap scheme, and Mr Ajay Bagga (AB), Chief Executive Officer of Kotak Mahindra Asset Management.

Excerpts from the interview:

Can you brief us on the Kotak Mid-cap Fund?

AB: Kotak Mid-cap is a diversified equity fund focused on mid-cap securities. As far as asset allocation is concerned, we have enabling clauses — we can hold cash of up to 35 per cent, 65 to 95 per cent in mid-caps and 0 to 30 per cent in stocks other than mid-caps.

The `others' category could include small-cap stocks we may find compelling.

It could also include stocks that we held, which have run up, where we still think there is a lot of steam left.

The idea is that I should not be forced to sell a good stock because I am constrained by the Rs 2,000-crore limit.

What is your take on the valuation of mid-cap stocks?

KA: The trend of smaller companies growing big will continue. Both the international environment and the domestic environment are now favourable to Indian companies.

The market has taken a few companies and is valuing them at a premium to the index.

These companies are, however, growing faster than the index and generating efficient returns on their capital. They also come off a lower base.

The rally in mid-cap stocks in the past two years is not only because of the earnings growth but also due to the re-rating of their valuation. In a forward-looking economy, smaller companies will out-perform the larger firms for two reasons. First, they come off a lower base. Second, the addition to capacities in their case is far higher than with larger companies.

You are making a case for a higher P/E for mid-caps. Is that re-rating over?

KA: It is not. The fact is the opportunities are not restricted to the domestic economy. However, the opportunity is not for the whole basket of mid-caps.

The P/E of the CNX Mid-cap Index will be equal to or lower than that of Nifty.

But there will be specific businesses that will grow at a faster pace and are more capital efficient than companies that make up such benchmarks as Nifty, Nifty Junior and CNX Mid-cap 200.

Since Nifty Junior is the benchmark, would it be correct to assume that you would be focusing on the larger among the mid-cap stocks?

KA: For the definition of mid-cap, we have taken that used by Value Research and more commonly followed world-wide; the top 70 percent in terms of market capitalisation are classified as large-cap, the next 20 per cent mid-cap and the rest small-cap.

Our basic objective is to capture the meat of the mid-cap market. Today, stocks with market capitalisation of between Rs 700 crore and Rs 5000 crore would be considered mid-cap. We will be focusing on stocks that fall in the 70-90 per cent band.

Most mid-cap schemes have the CNX Mid-cap 200 as their benchmark. But you have Nifty Junior. Is that not significant?

KA: If you look at the set of Nifty Junior stocks you will see that they broadly fall in line with the definition we are using.

We had a look at the CNX Mid-cap 200 but there is a constraint. The market capitalisation band is now between Rs 75 crore and Rs 750 crore for a six-month period.

This will make execution of the strategies difficult. Scalability of the fund size will also prove difficult. With Nifty Junior as the benchmark, scalability will not be a constraint. I can increase my fund size without affecting my liquidity.

I have not said that I will not invest in small-cap stocks. But I also do not want to be funding venture capital in an open-ended scheme. That is not the mandate.

I am running an open-ended fund. I would like to grow with the businesses subject to the company being relatively mature and having access to cheap capital.

It also must have a decent balance-sheet and good management values.

Kotak has maintained that is not comfortable with a large number of stocks in each portfolio. But mid-cap funds typically have about 50 stocks...

KA: Mid-cap stocks are far more volatile. Higher the number of stocks, lower the volatility. We are still crystallising our thoughts on this issue. As of now, we are thinking of 30-40 stocks to start with.

In the case of many fund houses, mid-cap schemes are now larger than large-cap funds. What fund size would you be comfortable with?

AB: I think there is enough opportunity. There are funds that are larger than Rs 750 crore and they are doing quite well. I do not foresee any issue in terms of not having enough stocks to invest in.

The market will also keep growing. You will find new stocks coming in. In addition, mutual funds are not growing as fast as the market capitalisation. There is an opportunity from that perspective too.

KA: Twenty per cent of the total market capitalisation, which covers the mid-caps, is about Rs 3,00,000 crore. There are therefore plenty of opportunities.

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