The tightening of exposure limits in multi-cap funds by the Securities and Exchange Board of India (SEBI) has put the Rs 27 lakh crore mutual fund (MF) industry in a spot. Industry executives are weighing several options, including scheme mergers, re-launching multi-cap funds as thematic funds, asking for a 'flexicap' category, and also seeking more time from SEBI for implementation of the new norms.
“We have already informed SEBI about the challenges this move can create for the MF industry and the regulator has asked to come back with data points to clearly highlight the issues in implementing this move,” said a senior executive of a fund house, requesting anonymity.
“We want to represent to SEBI that allocating 25 per cent, especially to small-cap segment will not be feasible, without having a large impact on investors. Even the NSE 500, which is the benchmark for multi-cap funds, has a weightage of 81 per cent to large-cap firms, 14 percent to mid-cap firms and just six percent to small-cap firms,” he said.
Fund houses say adding small-caps in multi-cap portfolios in large quantity is not favourable as this can significantly shoot up the risks for unitholders. “Small-caps don’t have the capacity to absorb large funds, due to their shallow liquidity. The impact costs when buying or selling small-cap stocks can be as high as 15-20 per cent, especially if large positions are to be moved. We are not going to get into forced buying of small-cap stocks in multi-cap funds, just because of the circular,” said another fund manager who also alluded to corporate governance challenges that are known to plague many such firms.
A new category, scheme mergers can emerge as options
Some fund houses, which have large-sized multi-cap funds, see the creation of a new flexicap category (somewhat like a dynamic fund that gives the power to fund managers to move within company sizes) as a viable solution. Such a category would allow fund managers to swing either way; even have a 100 per cent small-cap, if they see it fit, said the fund manager quoted above.
Fund houses are also ideating on scheme mergers, where the fund house can merge the multi-cap fund with a large-cap fund or a large- and mid-cap fund.
Under the existing framework, a large-cap fund is required to invest a minimum of 80 per cent of assets in large-cap stocks. The remaining 20 per cent of the scheme's assets are at the discretion of the fund manager.
Experts say merging with large- and mid-cap funds could be a more suitable option for some fund houses. “A fund manager is required to allocate a minimum of 35 per cent to large-cap stocks and a minimum of 35 per cent to mid-cap stocks. The remaining 30 per cent of scheme assets are still at the discretion of the fund manager, where he can make allocations across the capitalisation curve,” said Amol Joshi, founder of Plan Rupee Investment Services.
Another option is to convert the multi-cap funds into a thematic fund such as an ESG fund. However, only fund houses running strategies that meet the required environmental, social and governance scores, will be able to use this option.
SEBI wants the new norms to be implemented by February 28, 2021. The mutual fund industry also wants SEBI to consider extending this deadline to at least one year.What could this mean for mutual fund unitholders
Meanwhile, fund houses are allaying investor fears and are busy reaching out to investors via distributors and advisors about "the many possibilities" ahead and to prevent panic outflows.
As of August 31, the asset size of multi-cap funds stood at Rs 1.46 lakh crore, which makes it the second-largest equity category.
On concerns that multi-cap funds would be forced to immediately buy small-cap stocks and sell large-cap stocks, many fund houses have told distributors and unitholders that this is not likely to happen as fund houses are going to ensure that risk-return profile of their multi-cap strategies is not disrupted under any scenario.
If SEBI gives a window to mutual funds to merge the schemes or re-launch them in possibly a new ‘flexicap’ category, unitholders will be given the option to exit the schemes without any exit load. This exit window is required by regulations as unitholders are to be given the right to exit if there is any change in the fundamental attribute of the scheme.
Financial planners say unitholder can evaluate these options at a later stage when they come up, and for now, stay put in the multi-cap scheme they are invested in.
“Mutual funds are going to explore several options to avoid any disruptions to how the scheme is being managed. Once investors get clarity on how these schemes are going to be positioned, and if risk-profile of the scheme is really changing, they can take a call,” said Kirtan Shah, Chief Financial Planner at SRE.
Anatomy of SEBI’s multi-cap move
While a large section of the industry is expressing concern that SEBI had not consulted the industry or the Mutual Fund Advisory Committee before passing the circular on multi-cap funds, some executives pointed that SEBI has been advocating that a fund should be true-to-label from a long time.
In October 2017, SEBI rolled-out categorisation and rationalisation of mutual fund schemes. This was done to make sure funds are true-to-label and also there is no duplication of schemes.
This led to several fund houses merging their scheme, or re-positioning their existing schemes to comply with these norms, and some fund houses had to also churn their portfolios to fall in-line with the new regulations.
To be sure, while SEBI defined multi-cap funds as those that invest across large-cap, mid-cap and small-cap stocks, the regulator didn’t specify any minimum allocation for any of these market caps back then.
Most multi-caps ended up becoming large cap-biased. According to data from Morningstar, of the 35 multi-cap funds, 32 had over 50 per cent allocation to large-cap stocks. Of this, 28 schemes had between 65 per cent and 92 per cent large-cap allocation, as of August 31.