SEBI’s new rule for multicap funds!

SEBI’s new rule for multicap funds!

Last updated: 12 Sep, 2020 | 12:27 pm

SEBI’s new rule for multicap funds!

Latest rule

  • Sebi has now made it mandatory for multicap schemes to invest at least a minimum of 25% in large-cap, 25% in mid-cap and 25% in small-cap stocks. For example, 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.
  • The top 100 stocks by market capitalization come under large-cap stocks. The companies that are ranked 101-250 are mid-cap and the 251st company onwards comes under small-cap companies. 
  • All mutual funds will have to comply by this new regulation by January, 2021 

Previous rule

  • Previously, there was no such minimum investment guideline (into the category of stocks) for multi-cap funds. The multi-cap funds were required to 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.

How will this impact the market?

  • Currently, the total AUM of multicap funds stands at ₹1.46 lakh crore, out of which about 72% is invested in large-cap stocks. The exposure into mid-cap stocks is around 16.4%.  'So, in order to meet the minimum 25% allocation to midcaps, mutual fund houses will have to move an aggregate investment of Rs 12,600 crore into mid-cap stocks by January 2021.'
  • In case of smallcap stocks, the allocation is even lower at 6.25%. So, mutual fund houses will have to move about ₹27,000 crore into smallcaps over the next few months. 
  • 'As per the latest rule, the highest possible allocation in large cap stocks for a multicap fund is 50%. Hence, it is estimated that mutual fund managers will have to offload 22% or about ₹31,000 crore from large caps.'
  • Data shows that in 27 out of the 35 multi-cap schemes, large-cap stocks account for over 60% of the scheme’s investment and in case of 18 schemes, large-cap companies account for more than 70% of the scheme’s investments.

INDmoney Analysis

  • Given the huge polarisation in returns between large-cap stocks and midcap stocks, multi cap mutual funds were allocating a high percentage of the portfolio to large caps and generating decent returns in the last two years. The markets have been witnessing a heavy inflow into large cap stocks as investors flight to quality in these turbulent times
  • This regulation could make multicap funds riskier, as a minimum of 50% will now have to be allocated to small and midcap stocks. Smallcap stocks also have a higher impact cost (due to low trading volume and liquidity) compared to large cap stocks, which could lead to higher expenses for multicap funds. 
  • The mutual fund houses have said that they will make representations to SEBI, explaining that smallcap stocks do not have the capacity to absorb such a large inflow given their low market capitalisations. Among the NSE 500, smallcaps make up just 6% of the total market capitalization. Hence, fund managers will have to look beyond the top 500 stocks to comply with the new rule. 
  • There are various routes that a fund manager can take. Instead of adhering to these wights, they can reclassify a multicap fund to a flexi cap fund or a thematic fund or large and mid cap fund and also provide an exit to the user. These categories do not have the restrictions of a Multi-cap fund. 

What should you do?

Existing investors

  • For investors, Equity allocation amongst large, mid and small-cap segments should be based on the risk profile, investment horizon and liquidity needs. In case you have a long-term time horizon, it is advisable to wait for more clarity, as mutual fund houses have said that they will be making their case to SEBI. Fund houses can explore various options including switching investors to another fund, merge with another large cap fund, represent their case to SEBI and ask for a new Flexicap category.
  • In case you are uncertain about your time horizon and are sitting on gains in these funds, we recommend that you redeem the funds and re-allocate the amount to large-cap. Midcap and small-cap funds separately. Contact your wealth advisor to assist you with the same

Investors looking to deploy fresh capital

  • We advise you to invest in large-cap, midcap and small-cap funds separately rather than choosing multi-cap funds. Contact your wealth advisor to assist you with the same. We recommend stopping your SIP’s in multi-cap funds.

Please find your exposure to multicap funds. (listed below)