13 Sep Regulatory (SEBI) decision on multi cap funds asset allocation will broaden the market rally or just increase the risk of existing investors?
“In order to diversify the underlying investments of multi cap funds across the large, mid & small cap companies and be true to label, it has been decided to partially modify the scheme characteristics of multi cap fund,” said SEBI.
The market regulator said multi cap funds will now invest minimum 75 per cent of total assets in equities with 25 per cent each in large, mid & small cap companies. It said all the existing multi cap funds shall ensure compliance with the above provisions within one month from the date of publishing the next list of stocks by AMFI, i.e., January 2021.
Strategically most multi-cap funds are heavily skewed towards large-cap companies. Multi cap schemes of mutual funds have an AUM of Rs1.47 lakh crore as of Aug’20 with Large, mid & small caps accounting for 74%, 16% and 6% respectively. The new rules set by SEBI will entail multi cap funds to increase their holdings in mid and small caps by 9% (Rs 12800 Crore) and 18% (Rs27400 Crore) over the next 5 months. To meet the new norms, they will have to reallocate a fair bit of their large cap holding to small or mid-cap stocks. It will add to buying interest on small cap counters, which may impact liquidity and prices
|Multicap Fund Structure||Large cap Allocation||Mid Allocation||Small Cap Allocation||Equity Allocation||Debt Allocation|
|As on Date Current Structure||As Per Fund Manager||As Per Fund Manager||As Per Fund Manager||65%-100%||0-35%|
|New SEBI Guideline||Minimum 25%||Minimum 25%||Minimum 25%||75%-100%||0-25%|
Is it really required?
A glance through the portfolio of top 10 multi cap funds proved the point raised by analysts. As of August 2020 top ten multi cap funds have sum of Rs.1.2 lakh crore which is almost 82% of all multi cap funds, invested around 76.8% of that in large cap stocks. In other words, investors are getting large cap fund at the cost of multi cap fund. As per SEBI categorisation large cap fund should invest minimum 80% in large cap stocks, so multi cap are as similar as large cap in current scenario. However it all depends upon fund manager approach as some funds have allocation below 40% in large cap stocks.
Some of the MF industry stakeholders believe that the new allocations would increase the risk in Multi cap funds since most of them hardly have any exposure to high-risk small cap companies right now. However, the decision would brighten the return prospects also and would also help the small cap companies which have been struggling. So we just see the impact of the same on different stakeholders.
Impact on Fund Manager & Fund House (Multi Cap Funds)
In any multi cap strategy most portfolios would have larger tilts toward the nature of the market. As in the market , bigger companies usually have large market cap comparative to mid & small cap. We just check the same by looking at market cap split at different time periods.
|Average Market Cap Share||Large cap||Midcap||Small cap|
|As July- December 2017 AMFI List||67.96%||16.28%||15.76%|
|As Jan- Jun 2020 AMFI List||74.00%||15.54%||10.45%|
|New SEBI Guideline*||50%||25%||25%|
In above data we can see when mid & small caps hit their all time high in Jan 2018 and their valuation was also higher. On 1st Jan 2018 when trailing PE of CNX Midcap and Small cap was 52.55 and 106.81 even then their market cap share was near 16%.
So these guidelines will restrict fund managers’ decision making powers, reduce the flexibility to play different caps and their cycles and valuations which, on the other hand, may impact performance of the Multi Cap Funds. It also puts pressure to small cap liquidity which is already quite low. A Nifty 500 index fund is basically a large-cap fund now.
Market watchers also say that too much micromanagement will do more harm to the industry than good. “Even large-sized small-cap funds have been finding it difficult to deploy funds amid the prevailing uncertainty in the markets and we small-cap funds have frequently halted investor flows due to limited investment opportunities in this segment,” says fund manager.
Options Fund Houses have?
There could also be a possibility of some fund houses shifting their multi cap funds to other categories. SEBI’s allowed, multi cap schemes have many options to meet with the requirements of the circular based on preference of their unit holders.
a) Rebalance existing portfolio which could lead to potential inflows in mid & small-cap companies and
b) Merge existing multi cap schemes with existing large cap/focused funds and launch a new multi cap scheme or for instance Large Cum Mid cap Scheme.
c) AMCs would consider converting multi-cap schemes into thematic schemes, which do not have investment restrictions.
d) AMCs could inter-alia facilitate switching to other schemes by unit holders.
e) The last option would be to close down the multi-cap schemes and return the money to investors.
Impact on Markets (Multi Cap Funds)
What the market was missing after the categorisation rule came into effect was broadening of the market. Money was flowing into top 10-20 companies only. Analysts see this move is likely to lead to a short rally in small-cap stocks. “The fallout of the rebalancing by asset management companies would be visible in the equity markets, with the CNX small-cap index likely to sharply outperform, with buying interest from domestic institutions in the coming months,”. Analysts believe there will be little to no significant impact on large caps because of the money moving out as liquidity is not a problem there.
|Market Segment||Addition/Deduction Amt (Cr.)||% Impact Of Current Average Market CapAs on Jan-Jun 2020|
When we see the number of buying in mid & small cap of Rs.12800 Cr. and Rs.27400 Cr. It seems significant value however when we see the same value relative to the current average market cap of mid & small cap it is 0.60% and 1.92% only. For this reallocation fund manager to have time till February 2021, it will happen in phases. Therefore the new norms may not mean a sudden gush of money into small caps, the least represented category in multi-cap schemes.
Impact on Existing Investors
Multi-cap funds were preferred by investors because it offered flexibility to fund managers to invest across large, mid, & small-cap based on the opportunity. Some of the MF industry stakeholders believe that the new allocations would increase the risk in Multi-cap funds since most of them hardly have any exposure to high-risk small cap companies right now and it also increases minimum equity requirement to 75% from earlier 65%. Due to the same investors may decide to switch their investments into other categories like large, mid-cap or focused funds.
However about 40 per cent of the entire mutual funds’ equity investment of ₹7-8 lakh crore is concentrated in top 5-6 market-cap stocks such as Reliance Industries, HDFC Bank, HDFC, ICICI Bank, Tata Consultancy and Infosys. We believe current change will reduce concentration and overlapping of stocks in the investor portfolio. It will also help investors to select the fund purely based on a fund manager’s caliber to navigate the market while being invested in stocks across market-cap. The small-cap mutual fund schemes could also be indirect gainers from the new guidelines by the regulator.
Impact on Advisor
Advisor or financial planner plays a key role in choosing funds for their investors as a mutual fund is a key investment vehicle. In the last 2.5 years advisors and investors prefer multi-cap funds because of volatility in the broader market and current pandemic.
Advisors always prefer to choose even a multicap fund as per risk aptitude of their investor, like some fund managers take aggressive calls and some keep allocation in different segments as per nature of market. However current change may increase his job to review investor’s portfolio and advise some other options to them as per their risk profiling.
Conclusion (Multi Cap Funds)
This entire set of restructuring will be disrupted opposite to the one we saw in 2018, when SEBI first introduced scheme categorisation. It led to outflows from small & mid-cap. The inverse will happen this time, bringing inflows to small & mid-cap by mutual funds. The intention of this move by regulators was aimed at reducing risk of concentration in large-cap stocks, how it will shape up needs to be closely monitored in upcoming months. As an investor we would recommend to wait & watch till further developments and consult with their financial advisors or planners to do reallocation/rebalancing of portfolio.
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