Multi-cap Fund Tweak And The Conundrum For Fund Managers

The Securities Exchange Board of India (SEBI), the regulator for the Indian Stock Markets, has continued their endeavour to make mutual fund investing easier for common people.

On October 6, 2017, SEBI came up with a master circular which defined all kinds of mutual fund categories. In that circular it was mentioned that any Multi-cap fund should hold minimum 65% of its assets in equity or equity-oriented instruments. Over the years, Multi-cap funds have invested lion's share of their portfolio in large-cap stocks and very miniscule percentage in small and mid-cap companies.

Most Multi-cap funds were functioning more or less like a Large-cap fund. To do away this disparity, on 11th September, SEBI brought about another circular in which SEBI clearly stated that for any Multi-cap fund it is mandatory to hold 25% of its portfolio in large-cap stocks, 25% in mid-caps and 25% in small-cap companies. Minimum equity holding for any Multi-cap fund should be 75%. This compliance should be ensured by the fund houses by January 2021.

This very circular shook the entire landscape of Multi-cap Funds. Let us look at top 3 fund houses as per AUM. HDFC Equity fund has 84.05% holding in large-caps, 11.89% in mid-caps and rest of their portfolio in small-caps. ICICI Pru Multicap Fund has 73.97% in Large-cap and 16.97% in mid-cap. SBI Magnum Multicap Fund has 74.39% in Large-cap and 18.34% in mid-caps. Most funds were functioning as Large-cap funds under the banner of Multi-caps.

As per SEBI definition, if we sort all the listed companies from the highest market cap to the lowest one, the top 100 companies are defined as Large-cap, from 101-250 companies are Mid-caps and all the remaining companies are Small-caps. Most fund managers have opted to park their money in apparently safer and low volatile Large-cap companies during last 2 years. It resulted in a sell-off in mid-size and small size companies and a meteoric rise in large company's stock price. It created valuation disparity across market caps and market became very stock specific. Index heavyweight stocks pushed the benchmark index higher, whereas there was loom and doom in broader market. Through this mandate, the regulator tried to ease out this valuation difference and bring some balance in the broader market.

The said circular has stoked many rumours and speculations. The rebalancing of the Multicap fund portfolios dominated headlines of all leading financial electronics, print and digital media. Market experts hailed the move stating that it will create a level playing fields for the smaller names but also cautioned that market is skewed towards large companies and there is a reason behind it.

Market always chases earnings growth and only index heavyweights, who has got market dominance, managed to grow during last 8 quarters. If SEBI forces the fund managers to compulsorily invest in lesser known small companies, it will be harmful for the overall portfolio health. To fend off the speculation propagated from different quarters, SEBI has released another press release on Sunday, 13th September. In that press release, SEBI clearly stated that rebalancing of portfolios is not the only way out for the fund managers of Multicap schemes. They can opt for recategorization of the fund, for instance they can rename their multi-cap fund to large and midcap fund, they can facilitate their unit holders to switch to other schemes or they can merge their multi-cap scheme to large cap schemes.

Now if we consider at the market distribution, it will be very tough for the fund managers to allocate 50% of their scheme's asset to mid-cap and small-cap companies. Because, most companies in that segment has broken fundamentals, fractured balance sheet or unreliable management. There is not enough space to invest huge chunk of money in small and mid-cap universe.

There are handful names where fund managers could bet their investors hard-earned money. Another problem is trading volume. Most small companies trade in exchanges with 5-10% circuits. Deploying a big amount of fund is not easy due to lower volume and it will create huge price-fluctuations. As on 14th Sep, Nifty small cap index is trading at a PE (Price to Earning) multiple of 32.30 and a price to book ratio of 2.15. Whereas Nifty 50 which consists of all big and reliable names is trading at a PE of 32.79 and Price to book ratio is 3.21. So, smaller names are trading at almost same valuations compared to large cap companies. So, a fund manager will be reluctant to put money on lesser known names where he can park the same money on Mega-cap companies like Reliance and TCS.

Kotak Mahindra Mutual Fund who has got the largest AUM (Asset Under Management) amongst the multi-cap funds, is looking to merge their scheme with their large cap scheme. Few big funds are yet to take the call. It is very easier to reallocate the portfolio of the funds who has got lesser AUM compared to larger ones. So, those who have manageable asset size, with try to shift to small companies as they will not like to concede the multi-cap space to their competitors. Taking the cue from that there was huge buying interest in small cap and mid cap stocks on Monday. Nifty small-cap 250 index was up by 5.07% and Nifty midcap 100 index was in green by 2.63% whereas Nifty 50 was down by 0.21%.

About the author:

The author is working as an Investor Banker in Mumbai. He's has got 5 years experience in Treasury, Fund Management and Portfolio Management. He vigorously tracks Equity, Debt market and Mutual Fund portfolios.

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