The Hindu Business Line : Franklin India Small Companies Fund: Invest

FEW product categories in the mutual fund space can now evoke as much excitement as a mid-cap/small-cap fund. You can rest assured that the hype surrounding a close-end small-cap fund will be doubly so. Close-end funds that invest in smaller companies, however, generally make sense in a growing economy. That is the case now for India, even at the prevailing levels of valuation.

Investments can thus be considered in Franklin India Small Companies Fund. It is a close-ended fund, meaning you can invest in it only during the public offer. In contrast to Morgan Stanley Growth Fund, this fund will not be listed, and you will not get to buy the units at a discount to the NAV at a later date. The fund also offers liquidity in the form of redemptions every six months at a discount of about 4 per cent in the initial years. The discount narrows in later years. This means the fund strikes a reasonable and attractive compromise between liquidity and stability in funds under management that can enhance returns.

The fund is already open for subscription and closes on December 16. The fund is to be managed by Mr Satish Ramanathan, who has recently been co-opted as the fund manager of Prima, an open-end mid-cap fund from the Franklin Templeton India stable.

What this fund is not

Given that Small Companies is the first actively managed close-end fund to be launched in a decade, there is bound to be lot of expectations from this offer. Anything related to the capital markets but with restricted supply, also has the tendency to acquire a glow of its own. It is therefore important to be clear about what this fund is not.

This fund is not of the close-end venture-capital type variety. At the maximum, it can invest only 10 per cent of its assets in unlisted stocks. It is also not a small-cap fund. The fund will invest predominantly in stocks whose market capitalisation is less than about Rs 4,000 crore now. This fund can also invest up to 25 per cent of its assets in large-cap stocks. Forty-two months from allotment, in the run-up to rollover in January 2011, the fund can also invest even more in large-cap stocks to stay liquid.

This fund is also not managed by Mr K.N. Sivasubramanian, whose track record as a mid-cap fund manager has been among the best in India over the past decade. The fund manager designate, Mr Satish Ramanathan, does not have a fund management track record. He has built his career as an analyst so far.

What this fund is

The fund's benchmark index is CNX Midcap. The terms of offer, such as the leeway to invest in large-cap stocks and the definition of smaller companies, suggest that Franklin Templeton is acutely aware of risks associated with investing in smaller companies.

This fund, thus, could end up replicating Franklin India Prima in a close-end format. Evidently, as these restrictions will lower risks, expected returns, too, will be lower than those from a fund that invests entirely in small-cap companies.

As the appetite for risk has increased now, that may be a trifle disappointing for some investors, though it may not be a bad outcome altogether. In the event of Indian industry growing at 8 per cent plus over the next five years, returns to investors will still be attractive. Returns will be higher than investing only in large-cap stocks that now promise only high single-digit returns. The time is indeed ripe for investing in a close-end mid-cap fund. This is a worthy experiment fully deserving of investor backing.

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