Time to invest in a mid-cap fund?

Franklin India Prima is in the news again.

In February this year, the fund was concerned about its large size and had stopped fresh investments. From June 19 onwards, it will be open to new investments again.

So, if you have had this fund on your investment radar, you could check it out. Here is some information that should help you make a decision.

Returns from mid-caps are volatile

The Franklin Templeton group houses three of the country's largest mutual funds: Franklin India Flexi Cap (manages Rs 3,045 crore -- Rs 30.45 billion), Franklin India Prima (Rs 2,445 crore -- Rs 24.45 billion) and Franklin India Bluechip (Rs 2,368 crore -- Rs 23.68 billion). These were the figures on April 30, 2006.

The reason for this comparison is to show investors that mid-cap funds are more volatile that large-cap funds.

If we compare the returns of these three funds, you will notice that Prima is more volatile than the other two. Sure, it can give great returns too. Check the three-year and five-year returns; it beat the average returns of diversified equity funds by a large margin. But, in the short term, it fell hard.

For example, during the calendar years 1995, 1996 and 2000, the fund lost more than an average diversified equity fund. But its extraordinary performance during the booming market has meant excellent results on an overall basis.

Results of three Franklin Templeton funds compared with the average return of diversified equity funds as on June 14, 2006.

Like any other mid-cap fund, be prepared for short-term losses and volatility. Also, being much smaller companies, mid-caps are more risky than large-caps. If this bothers you, avoid a mid-cap fund.

Size does matter

While it cannot be denied that Franklin India Prima is managed by some of the finest brains in the mutual fund industry today, the fund's large size is cause for concern.

This is specifically with reference to mid-cap stocks. In fact, it was due to the large size of the fund that Franklin India Prima opted to close fresh investments. It is difficult to invest such huge amounts in good mid-caps without affecting the price too much.

Let's say a fund is managing Rs 1,500 crore (Rs 15 billion) and wants to invest just 5% of that in one stock. Let's say the market capitalisation of that stock is Rs 1,500 crore. This one fund will then own 5% of that stock.

If the fund decides to buy such a stock, the price will shoot up. If the fund wants to sell the stock, the price will come crashing down because the fund has such a large holding in that stock.

After all, stock prices change in relation to how much money is chasing them.

That is why investing in mid-caps is more volatile as compared to large-caps. Moreover, the former are riskier because these companies still have to prove their mettle. Besides, they are more susceptible to the vagaries of the business cycle than larger companies. Their profits and earnings could really dip.

There is always a price to pay for higher returns. In mid-cap versus large-cap, it is volatility and risk coupled with higher returns. It is for you to decide whether you are up to it. If yes, ignore short term gyrations and be prepared for a long ride.

Data and inputs from Value Research

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