MC Exclusive: No restriction on flows or portfolio construct for small-cap funds; disclosure on concentration risk mandatory

The advisory comes after months of deliberations the mutual fund industry has had with the capital market regulator arising out of the surge in demand for small-caps funds as the segment turns frothy with frenzied retail interest.

There will be no restriction on mutual funds attracting fresh flows into their fund schemes or launching new products in the small- and mid-cap space, according to the Sebi advisory on schemes in this category.

However, all funds will have to make uniform disclosure with respect to concentration of investors as well as the concentration of stocks in portfolios of fund schemes in these categories to give a sense of the risk associated with these schemes, sources said.

“Any restriction will be at the fund house’s discretion. But funds will have to make uniform disclosures in five to six buckets on the risk associated with small- and mid-cap schemes,” according to a source in the know.

The six points where disclosure will be mandated include 1) Risk related to hypothetical liquidation of portfolio during stress time, say, a 10 percent redemption or a 30 percent redemption 2) concentration of portfolio 3) concentration of investors (assets contributed by top five and top 10 investors) 4) portfolio construct between large, mid, small-caps and cash 5) valuation parameters like P/e, P/b etc 6) portfolio investment risk metrics like Sharpe ratio.

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This final advisory comes after months of deliberations the mutual fund industry has had with the capital market regulator arising out of the surge in demand for small-caps funds as the segment turns frothy with frenzied retail interest. Sebi has been concerned about the potential impact of sudden redemptions in funds following a change in sentiment or any other factor that could make funds sell their more liquid holdings and saddle remaining unitholders with illiquid stocks.

Thus far, mutual funds have addressed the risk in their own way, to suit their strategic objectives, and not collectively as an industry. That flexibility will continue with the regulator now pressing for more disclosure to bring to focus the liquidity risk faced by individual fund schemes, industry sources said. This is significant as it allows smaller mutual funds to grab market-share or make opportunistic moves if and when there is an opportunity.

“At all times, there is always someone selling and someone else buying. So when sudden selling happens, there will be somebody trying to exploit the selling. Market forces have to be allowed to work. That’s why it is good thing for the industry to not work in unison but independently on their selling as well as management strategies,” an industry observer said.

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