Mutual Funds

Multi-Cap Funds Must Invest 25% each in small, mid and large cap stocks as per SEBI’s New Guidelines

SEBI’s new guideline mandates multi-cap schemes to stay true to its name and ensure at least 25% of its assets are invested in each large-cap, mid-cap, and small-cap stocks. As a result, the multi-cap funds will have to rejig their portfolios and swap a large chunk of their investments from large-cap stocks to mid- and small-cap stocks, which can cause a run-up in mid and small-cap stocks as they may see inflow to the tune of Rs 30,000 crore.


SEBI published a circular on Thursday, mandating multi-cap funds to invest a minimum of 25% each in large, mid and small cap stocks. Until this circular came into effect, multi-cap funds had the freedom to invest the money as per the discretion of the fund manager without any restrictions. For example, a fund manager could have 85% allocation towards large-cap stocks and could still call itself a multi-cap fund. But with this circular in effect, this is now going to change how the multi-cap funds deploy their money.

According to the circular, “In order to diversify the underlying investments of Multi Cap Funds across the large, mid and small cap companies and be true to label, it has been decided to partially modify the scheme characteristics of Multi Cap Fund”

The circular further states that at least 75% of the total assets of multi-cap funds will now have to be invested in equity & equity related instruments (as opposed to 65% earlier). Further, such funds will have to deploy at least 25 percent of its corpus to each large-cap, mid-cap, and small-cap stocks.

To understand it simply, SEBI has instructed that if a multi-cap fund has an asset under management (AUM) of Rs 1,000, it will now have to invest at least Rs 250 each in the large-cap, mid-cap, and small-cap universe. As for the rest Rs 250, the fund managers will have the discretion to invest in any category they prefer or even keep it as cash. Technically, if the fund manager still prefers, for example, large-cap stocks, he can maintain up to 50% exposure in them, in this case, up to Rs 500. The rest will be split equally in small and mid-cap stocks, i.e. Rs 250 each.


But aren’t multi-cap funds already distributing fairly to stocks of different market capitalization?

If that were the case, why would SEBI need to interfere at all?

We scanned through the multi-cap funds’ universe and found out that while these funds were essentially labeled “multi-cap fund”, {in reality} most of them were acting as a large-cap fund. The portfolios of most multi-cap schemes were skewed towards large-cap stocks.

Let us take the example of Kotak Standard Multicap Fund. As of today, the fund’s AUM, according to the fund’s website, stands at Rs 29,714 crores. A quick look at the portfolio and you will notice that more than 77% of the scheme’s money is invested in large-cap companies and only 1.18% is directed to small-cap companies. It is not just with Kotak Multicap. When you analyze the portfolios of other midcap funds, including popular ones like HDFC Equity Fund (83%), BNP Paribas Multi Cap Fund (76%), DSP Equity Fund (71%), Motilal Oswal Multicap 35 Fund (85 %), you’d find that a large percentage of their corpus is invested in large-cap funds, often over 70% some even going beyond 80%.


What impact will this new rule have?

This new SEBI rule will not only affect the mutual fund investors, but also the stock markets at large. As of August 2020, of the total 323 funds categorized as “equity schemes” there are a total of 35 multi-cap funds, as per AMFI data. These multi-cap schemes together have an AUM of Rs 1,46,708.38 crore.

Now, to be compliant, the fund managers will be prompted to rebalance their portfolios. As a result, we will see a big chunk of money moving out from large-cap stocks and into mid and small-cap stocks. So, from now until January 2021 (deadline set by SEBI for fund managers to adhere to the new guidelines), we will see a gush of investments towards mid-cap and small-cap companies. Our estimate is that this move will see new buying in mid- and small-cap stocks to the tune of Rs 30,000 crore. Since mid-cap and small-cap stocks are not very liquid, the sudden interest in these stocks could spike their prices. Is it an opportunity for equity investors to rush and invest in midcap companies or buy mid-and small-cap funds? For now, this is a rhetoric question – food for thought. However, before you make any impulsive moves, be careful, and make sure your investment decision is aligned to your long-term portfolio goals.

We believe that finding opportunities in mid-cap and small-cap stocks in this small timeframe and deploying such a large part of their corpus in them would be challenging for even the best fund managers. It may even severely impact the returns of the scheme. Hence, the second possible outcome of this guideline could be an internal restructuring of the schemes. We may see fund houses merging their existing multi-cap schemes with existing large-cap ones and eventually launch a new multi-cap scheme.


Is this the right move by SEBI?

Back in October 2017, SEBI did a mutual fund category shake-up by issuing guidelines to recategorize and standardize all mutual fund categories. It was a step in the right direction. Earlier due to unclear guidelines, fund managers often strayed from their defined scheme objectives, increasing the risk exposure of the investor. That shake-up was crucial to safeguard the interest of the investors, clear out ambiguities, and simplify their investment decision.

While this new guideline lays down that multi-cap funds should be “true to their label”, it does border somewhat towards micro-management by the regulator and limits the freedom of the fund managers. The whole point of a multi-cap fund, for some, could be that there is a flexibility on part of the fund manager to move between large-mid-small cap stocks as they seem appropriate in the given market conditions. The rigidity of the allocation may not align with investor’s expectations from the fund and at the same time chains the fund manager.

Will this regulation be a win for the investors or will it negatively impact their returns in the long term? Time will answer this question!

What do you think of this new SEBI guideline? Tell us in the comments box below.

Arihant Team
The Arihant Team believes everyone deserves access to sophisticated financial advice. From day one, our mission has been to help make investing easier and accessible to every Indian. Our team of experts are curating informative and research-based article on this blog, to help make investing and managing your money easier for you!

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