Kotak Pioneer Fund Review: Promising or is it too vague?

Last Updated on January 11, 2022 at 9:32 am

Kotak Pioneer Fund is a thematic open-ended mutual fund that aims to invest in domestic & international companies that pioneer change and innovation. The NFO period is ongoing and closes on Oct 23rd 2019. Let us find out more about the investment strategy and it is worth considering.

What is the definition of a Pioneering Innovations theme? According to the scheme document of Kotak Pioneer Fund, it will hold stocks of companies that embrace new forms of production, technology, distribution or process to challenge and displace existing businesses. This, the AMC believes will ensure competitive advantage, cost efficiency and growth.

This definition is largely subjective and at the moment, no independent third party in India to ratify or test. Not just the performance of the fund (see benchmark section below) but also the portfolio of the scheme. We have no choice, as of now, but to believe what the AMC marks as a pioneer stock!

What is the asset allocation of the fund? Equity and Equity Related Securities of
companies having pioneering innovations theme: 80% to 100%. Out of this, up to 35% can in international stocks via overseas mutual funds or ETFs.  The rest of the portfolio can be filled with other types of stocks, bonds and the obligatory 10% of REITs & InvITs.

What is the investment universe of Kotak Pioneer Fund? 

The fund can operate without any market cap or sectoral limitations. The AMC has provided this image in the scheme presentation that illustrates how the scheme will differ from diversified equity funds.

While all diversified fund would also invest in pioneer innovators, Kotak Pioneer Fund would specialise in it. This comes with its own set of risks (see below).  The AMC has identified a stock universe of about 120 companies as of now.

What are the risk factors? In addition to the usual risk factors associated with all mutual funds, especially those that invest part of the portfolio in foreign stocks, there are additional risks with a thematic fund. As with life, things may not go as planned. The “Pioneer innovators” held in the scheme may not fire as planned. They may either fail to disrupt established players or the disruption could be short-lived.  Change in government policy can affect the business.

Naturally, the treatment (not cure) is diversification, across sectors and across the market cap. For example, hold enough established players who invest partly in innovation

Kotak Pioneer Fund’s home-made benchmark!

A mutual fund’s benchmark has only one purpose. Evaluate the risk and reward of the active fund manager for the associated expenses. This benchmark should be created and maintained by an external agency to prevent conflict of interest. Sadly this is not the case for Kotak Pioneer Fund.

The scheme benchmark is 85% IISL KOTAK INDIA PIONEERING INNOVATIONS INDEX + 15% MSCI ACWI INFORMATION TECHNOLOGY INDEX TRI.

The second index as you may have guessed is for the international equity component and also suggests that this fund will hold foreign IT stocks. The MSCI ACWI Information Technology Index holds large and mid cap funds across 23 developed markets and 26 emerging market countries.  These are the current top ten holdings.

The fun does not end there. The AMC created this index with 50 stocks based on the last six-month average market cap and back-tested the same, static 50 stock folio since Jan 1st 2013 and created these graphs (source: scheme presentation linked above). Now is this hindsight bias or survivorship bias or both?

Amusingly the margin of outperformance has come down recently! The IISL index is currently 81% large cap and the rest mid cap. So that is promising in terms of risk. Also, it is well-diversified as seen below.

Is Kotak Pioneer Fund Promising or is it too vague?

The idea of picking businesses that invest in innovation is quite promising.  However when a fund does only that the risk becomes too concentrated. That said, the benchmark has a large cap tilt and well-diversified across sectors (as on date). The main problem is, how the stock universe is defined is not clear. There is no independently created index portfolio to understand portfolio construction and benchmark the fund’s performance.

As an analyst, I will be watching this fund, along with ICICI Prudential India opportunities fund and Quantums ESG fund with keen interest. However, I see no pressing hurry to commit any money (even a small amount) towards this.

There is always an urge to have a “small exposure” to such NFOs, but small exposure will result in insignificant returns and guarantees portfolio clutter as explained in this video.

So when your Kotak bank RM suggests this fund as the next big thing to you, simply say, no, thank you.