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Tuesday, September 22, 2020

Explained: Sebi’s multicap directive — why are mutual funds unhappy?

If a multi-cap scheme of a fund house has an AUM of Rs 10,000 crore, it will have to invest at least Rs 2,500 crore each in the three categories of stocks. The fund manager is free to invest the remaining Rs 2,500 crore in any category they want.

Written by Sandeep Singh , George Mathew , Edited by Explained Desk | Mumbai, New Delhi | Updated: September 13, 2020 10:56:34 am
SEBI, SEBI cap on mutual funds, Mutual funds investments, Multi cap schemes, Express explaine,d Explained economics, Indian expressAccording to the Sebi definition, the first 100 companies in terms of full market capitalisation are large-cap. The companies that are ranked 101-250 are mid cap and the 251st company onwards comes under small-cap companies.

The latest directive by the Securities and Exchange Board of India (Sebi) slapping limits on stock market investments of multi-cap schemes of mutual funds seems to have upset the plans of mutual funds as they will have to churn around Rs 40,000 crore worth stock in their portfolios.

Fund houses, which will be forced to go for a portfolio reshuffle over the next few months and shift their allocation of multi-cap funds from heavily weighted large-cap companies to mid and small-cap companies, wonder why they are being targeted while foreign portfolio investors (FPIs) — bigger players than domestic fund houses — are free to invest in any stocks without limits.

What’s the Sebi directive to mutual funds?

In a circular issued on Friday, Sebi has specified that the minimum investment in equity and equity-related instruments of large, mid, and small cap companies in multi-cap schemes should be 25 per cent each of total assets under management of the scheme. So, if a multi-cap scheme of a fund house has an AUM of Rs 10,000 crore, it will have to invest at least Rs 2,500 crore each in the three categories of stocks. The fund manager is free to invest the remaining Rs 2,500 crore in any category they want.

Earlier, there was no such minimum investment guideline (into the category of stocks) for multi-cap funds. While Sebi guidelines said that multi-cap funds should invest at least 65 per cent into equity and equity-related instruments, the fund managers were free to allocate the money into large, mid or small caps. In fact, data shows that few of the schemes have near nil allocation to small-cap companies and 9 out of the 35 multi-cap schemes invested less than 5 per cent into small-cap companies.

Why are mutual funds unhappy?

Mutual funds were getting decent returns by investing in large-cap stocks, which were leading the Sensex rally in the last two years. On the other hand, mid and small cap stocks fared rather poorly when compared to large stocks. Fund managers also want the Sebi to slap similar curbs on foreign investors (FPIs). “Investors won’t benefit from this directive. Their returns may come down also or the schemes may carry higher risk. Mid and small caps don’t offer the desired comfort level to fund managers. The move will only benefit small stocks and market players who have invested in such stocks. Do we have enough small stocks in which we can entrust the money of investors? Why are FPIs not given any such directives? FPIs are free to invest in any stocks. One also wonders whether it’s to cool down the market when the economy is plunging,” said the senior official of a private sector fund house.

While FPIs have invested Rs 9.33 lakh crore in Indian equities, domestic MFs equity investments amount to Rs 7.69 lakh crore.

What are large-cap, mid-cap and small-cap companies?

According to the Sebi definition, the first 100 companies in terms of full market capitalisation are large-cap. The companies that are ranked 101-250 are mid cap and the 251st company onwards comes under small-cap companies. The categorisation has been done to ensure uniformity in respect of the investment universe for equity schemes. Mutual funds have been focusing on the top 100 large-caps as many of them are good performers and give decent returns to investors.

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What does it mean?

Data sourced from the MF industry shows that multi-cap schemes have total assets under management of around Rs 1.45 lakh crore and of that around 1.05 lakh crore (72%) is invested in large-cap stocks. The exposure into mid-cap and small-cap stocks is around 16.4 per cent and around 6.25 per cent respectively. So, in order to meet the minimum 25 per cent location to mid and small caps, fund houses will have to move an aggregate investment of Rs 12,600 crore into mid-cap stocks and move an aggregate investment of Rs 27,000 crore to small caps. So, funds amounting to Rs 40,000 crore will move to mid-cap and small-cap companies. Though Sebi has given the MF industry four-months time to revise their portfolios, industry insiders say that the rebalancing of the portfolio will start as early as coming Monday.

What will this reshuffling lead to?

Since a lot of the rebalancing will result into funds moving out of large-cap companies to mid-cap and small-cap companies, this is expected to resulting into a decline in share prices of some large-cap companies and surge in share prices of mid and small-cap companies. As funds amounting to Rs 27,000 crore are set to chase good quality small-cap companies, market participants say that it may lead to a big surge in share prices of some good small-cap companies. The move will also result in clearer differentiation between large-cap funds and multi-cap funds as a majority of the muti-cap funds currently have their investments in large-cap companies. Data shows that in 27 out of the 35 multi-cap schemes, large-cap stocks account for over 60 per cent of the scheme’s investment and in case of 18 schemes, large-cap companies account for more than 70 per cent of the scheme’s investments.

What should investors do?

As mutual funds have to complete the whole exercise by January 2021, the rebalancing of portfolio will see MFs buying small-cap stocks worth at least Rs 27,000 crore purely on this account and mid-cap stocks worth Rs 12,600 crore. This will see a surge in share prices of mid-cap and small-cap companies. Since it is tricky to find out the stocks in which they would invest, investors can follow the passive mode of stock picking. They can invest into well-performing mid and small-cap schemes of mutual funds. As the mid and small-cap stocks rise on account of fresh purchase by mutual funds, the schemes that hold those companies will witness a rise in their NAV going forward. So, investors will see a better return in schemes investing in these companies.

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