Nirav R Karkera
Over the next few days, we can expect social media and WhatsApp groups to be swamped with tips on small/midcap stock prices and index swings. All of these speculations have come about in light of SEBI's latest circular requiring multi-cap funds to realign asset allocations.
Late last week, SEBI released a circular prescribing the minimum allocations that multi-cap funds must make towards companies belonging to the large, mid and small-cap segments of the market. This is a follow-on to the mega circular on re-categorization & rationalization of mutual fund schemes in 2017. Fund houses are offered time till January 31, 2021 to rebalance portfolios in consonance with the guidelines.
Taking liberties with allocations
Fund houses have been taking significant liberty in managing the asset allocation in multi-cap assets rather dynamically, which at times results in a skewed orientation towards specific market capitalisations. While there is nothing very wrong with being flexible, it also does not entirely reflect a true-to-label management and could lead to distorted perceptions for new investors.
To ensure that a fund is true-to-label, SEBI has now mandated multi-cap schemes to invest a minimum of 25 per cent each in large, mid and small-cap stocks. This ensures that under no circumstances can a multi-cap fund have a skewed market-cap orientation, i.e., allocation above 50 per cent to any specific segment.
Along with the instructions on market-cap allocations, SEBI has also raised the minimum investment of such funds in equity/equity-oriented instruments to 75 per cent from the previous 65 per cent to ensure efficient and true-to-label capital deployment.
What does the category look like right now?
The category manages ~Rs 1.46 lakh crore worth of assets, of which ~Rs 8,700 crore (~6 per cent) is parked in small-cap stocks and ~Rs 24,000 crore (~16 per cent) in mid-caps. So, clearly, the category is heavily skewed towards large-cap stocks and is nowhere close to what SEBI suggests as a true-to-label construct.
For perspective, of the 35 active schemes categorised as multi-cap, only four have an allocation of less than 50 per cent towards large-cap stocks and perhaps only one fund that almost fits the new SEBI mandate.
Fund managers may have to churn almost Rs 30,000 crores from large-cap holdings to small-caps and ~Rs 13,000 crores from large-cap shares to mid-cap stocks.
But presuming that fund houses will simply dump large-cap holdings and buy small/midcaps in bulk would be quite naïve.
To comply with the regulation, we can see fund houses resort to one of the following available alternatives.
Rebalance existing portfolios: While this is an option, it may be suitable only for select AMCs. Some have the expertise across market-cap segments, and their portfolios offer the flexibility of realigning without hurting the performance. For a few, their existing asset allocations may already very close to the prescribed guidelines, so rejigging may be easier. This will be done over a period till end of January 2021, ensuring a well-calibrated, surgical rebalancing exercise with minimal collateral damage to the performance.
Re-categorization: It is possible that funds would want to re-categorize their funds to another segment – large-cap, large and mid-cap, value, focused or perhaps thematic. So, anything offering a framework that absorbs the existing portfolio as-is may be the recourse. There’s a good probability of funds resorting to this option.
Scheme mergers: Fund houses may want to merge their multicap funds with another strong portfolio, which in combination will be able to retain the quality/philosophy while complying with the guidelines.
Industry representatives may try to submit a proposal for creating of a new flexi-cap category, allowing for portfolios running a flexible mandate to re-categorize. The odds here are even.
However, the important thing to note is that in any situation, fund houses have a variety of options available at hand to comply with the SEBI guidelines without compromising on portfolio quality or creating a ruckus in the markets.
What is the takeaway for an investor?
This is an important development. Investors of multi-cap funds must review their portfolio majorly from asset allocation and product suitability standpoints. It is also important to consider the strength and credibility of the fund house and manager. While the previous mandate allowed fund managers to play to their strength arenas in terms of market-caps, the lack of flexibility warrants expertise across market segments. This, obviously, matters if the fund chooses to rebalance its portfolio for alignment. It would be smart to provision for the above changes as a contingency.
Investors must stick to asset allocation and fund selection principles. They must not react in an attempt to time the market. Funds choosing to rebalance will realign the portfolios over the next five months, gradually. The materiality of the impact will not be significant – especially for long-term mutual fund investors.
Investors must understand that the market runs deep enough to not get swayed by small waves. Unless fundamentally essential, it is advisable to resist the urge to act upon this development.
The move from SEBI should be viewed as a step in the right direction towards protecting investor interests. The new guidelines ensure distinction among seemingly overlapping categories.(The writer is Head of Research, Fisdom)