Why SEBI’s move on multi-cap funds is disruptive

By Kaustubh Belapurkar |  11-09-20 | 
 
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About the Author
Kaustubh Belapurkar, Director of Manager Research, Morningstar Investment Adviser India.

In 2017, the Securities and Exchange Board of India introduced categorisation and rationalisation of mutual funds schemes so that investors could make an accurate comparison of schemes.

  • Large-cap fund: At least 80% of its portfolio in large-cap stocks
  • Mid-cap fund: At least 65% of its portfolio in mid-cap stocks
  • Small-cap fund: At least 65% of its portfolio in small-cap stocks

Multi-cap funds stood out as they gave the fund manager complete agility in which market cap to zero down on. He could make his selection based on which stock he saw potential in and where valuations were not stretched. The only restriction was that 65% of the portfolio must be in equity.  Although Many such funds have traditionally been run with a large-cap bias in the range of 60-75%, some going as high as 85-90% depending on their views on relative valuations between the three segments.

The latest SEBI regulation undoubtedly has many ramifications.

It constrains the ability of mutual funds in a category that boasted of its go-anywhere flexibility.

Fund managers will have to keep a minimum 25% in small-cap stocks, 25% in mid-cap stocks and 25% in large-cap stocks. So the truly flexible portion of the portfolio is now restricted to just 25%.

The pressure on small caps.

What constitutes a small-cap company according to the definition by SEBI? The top 100 companies in terms of market capitalisation would be considered as large caps, the 101st to 250th companies would be considered as mid-caps and 251st onwards would be considered small caps.

Would these companies be able to absorb the buying that is going to happen now as fund managers adjust their portfolios? Execution will be crucial to manage the impact costs.

I crunched some data and here is what it reveals, with some degree of approximation.

The AUM of multi-cap funds is Rs 1.46 lakh cr.  Majority of the Multi-cap funds have run with a Large Cap bias. The new requirements will require them to reallocate significant portions from large-cap stocks to smaller fare.

The new allocation requirements will need AMCs to reallocate Rs 40,700 cr from large-cap stocks to mid caps (Rs 13,000 cr) and small caps (Rs 27,700 cr). This will put tremendous buying pressure on small-cap counters.

The pressure on investors.

Investors will need to reassess their multi-cap fund exposures depending on their desired allocations across the capitalization curves. For instance, if an investor already has a significant exposure to mid- and small-cap funds, having a multi-cap fund may not be a good fit anymore.

Also, multi-cap funds that have an international allocation will not be able to increase it to more than 25% of the portfolio.

Let me end with one positive outcome.

It is worth noting that many multi-cap funds that had a significant overlap with their large-cap counterparts will find themselves in a different position going ahead. Thanks to the new regulations, the large-cap exposure will be 50% at the most.

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JASKARAN SINGH
Sep 15 2020 07:19 PM
 Isn’t the time period given to realign portfolios too short? Would it not make markets more volatile than they are already? Have the Fund Houses no dialogue with SEBI in the matter?
Wouldn’t the Fund Houses be attempted to reclassify the Funds or even fold them into existing Large Cap funds? If they do, what will SEBI do?
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