SEBI caps multi caps!
A ship in harbor is safe, but that is not what ships are built for—John Augustus Shedd
Perhaps that’s the message SEBI wants to send out through its latest policy decision.
On September 11, 2020, the market regulator revised the asset allocation norms which now require multi cap funds to invest at least 25% each in large caps, mid caps and small caps.
Multi cap funds have time until January 2021 to comply with the new rules.
Why this change?
SEBI issued categorization and rationalization norms on October 06, 2017 to standardize the risk-return trade-off for all schemes in the same category. According to those norms, any open-ended equity fund that invested 65% of its assets across the spectrum of the market capitalization curve was a multi cap fund.
The same circular also offered the definitions of large, mid and small caps, which were as follows:
- Large caps: First 100 companies on the full market capitalization basis
- Mid caps: 101st to 250th company on the full market capitalization basis
- Small caps: 251stcompany onwards
Since the market regulator offered freedom to fund houses in choosing their desired market cap allocations, multi cap funds operated like flexi cap funds until now. However, under challenging economic conditions, many multi cap funds found solace in taking a defensive stance—which perhaps made them look like large cap funds.
At present, there are 36 multi cap schemes which collectively manage a little over Rs 1.46 lakh crore according to portfolios disclosed on August 31, 2020.
Camouflage: Large cap or multi cap?
(Source: ACE MF)
What are the implications of the revised norms?
Multi cap funds might have to sell off large caps worth Rs 38,904 crore and invest Rs 12,456 crore and Rs 26,449 crore, respectively, in mid and small cap companies.
The pace and volume of churning will differ significantly from one scheme to another. The top-10 schemes (AUM wise) account for 82% of the category AUM. For them, the exercise of rejigging the portfolio could be more strenuous.
Is reshuffling going to be an arduous activity for these 10 funds?
Data as on August 31, 2020
(Source: ACE MF)
For instance, Kotak Standard Multicap Fund held 73.5% of its assets in large caps as on August 31, 2020 while Sundaram Equity Fund had 76.9% exposure to large caps. The former has been the largest fund in the multi cap category with its AUM of Rs 29,704 crore while Sundaram Equity Fund has an AUM of Rs 600 crore.
Therefore, to adhere with the new norms, Kotak Standard Multicap Fund will have to invest nearly Rs 7,100 crore in small caps whereas, Sundaram Equity Fund may have to invest a little over Rs 100 crore.
By definition, the equity allocation of multi cap funds should go up by 10 percentage points i.e. from 65% to 75%. According to the portfolio disclosed on August 31, 2020, 35 out of 36 schemes held more than 75% equity assets in their portfolios. That said, some funds investing overseas may have to prune their allocation to foreign equity assets since they are classified as other assets.
It seems companies beyond the first 250 companies, based on full-market capitalization, are likely to be the biggest beneficiaries of the regulatory changes previously mentioned in this article. Small cap companies which haven’t seen much institutional interest over the past 2 years might finally witness sustained inflows. Although the economy is going through turbulence, not all small caps are vulnerable. In fact, some of them are available at multi-year low valuations. It will be interesting to see if the performance of small cap funds improves in the foreseeable future. SBI Small Cap Fund, Nippon India Small Cap Fund and Axis Small Cap Fund have been the top performers for the 5-year time period.
Now that multi cap funds will have to spread their allocations across the cap curve, their returns would be more in line with the broader market returns.
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