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BT Buzz: How changes in multi-cap funds will affect your investment after new SEBI rules

The new SEBI norms will have a huge impact on your multi-cap funds, which have been investing predominantly in large-cap funds so far

Mutual funds have been given around 4 months to comply with the new norms Mutual funds have been given around 4 months to comply with the new norms

KEY HIGHLIGHTS

  • Many multi-cap funds typically invested 70-80% in large-cap stocks
  • After new rule, funds will have to invest 25% each into large, mid and small-cap stocks
  • With a huge inflow of funds from multi-cap funds, mid and small-cap stocks will become costly
  • This will bring a fundamental change in risk and return dynamics of the category
  • Investors who do not want higher exposure in risky stocks will have to move to large-cap funds

Multi-cap funds, which are one of the most popular categories of equity mutual funds, are going to change fundamentally. The Securities and Exchange Board of India (SEBI) has come up with a new set of guidelines, which require these funds to invest at least 25 per cent of their total assets into each of the three categories -- large-cap, mid-cap and small-cap. Overall, the minimum investment in equities by these funds is required to be not less than 75 per cent at any given point of time.

Mutual funds have been given around 4 months to comply with the new norms. "All the existing Multi-Cap Funds shall ensure compliance with the above provisions within one month from the date of publishing the next list of stocks by AMFI, i.e. January 2021," the SEBI guidelines said.

Big migration of investment into mid and small-cap stocks

This is going to have a huge impact on your multi-cap funds, which have so far been investing predominantly in large-cap funds. "At present, the multi-cap funds have almost 70 per cent of their allocation to large-cap stocks and the balance to mid-cap and small-cap stocks," says Joseph Thomas, Head of Research, Emkay Wealth Management.

Some leading funds went even higher in their exposure to the large-cap category. "Many such funds have traditionally been run with a large-cap bias in the range of 60-75 per cent, some going as high as 85-90 per cent, depending on their views on relative valuations between the three segments," says Kaustubh Belapurkar, Director, Manager Research Morningstar India. The maximum large-cap exposure that a multi-cap fund can now have is restricted to 50 per cent.

The new SEBI guidelines will now force these funds to shun a big part of their large-cap exposure and move funds in mid and small-cap stocks. "The new regulation will make it mandatory that any market cap may have a minimum allocation of 25 per cent, and therefore, to the extent of the excess allocation to large caps mutual funds will have to reduce the allocation, that is, 20 per cent, and move into mid-caps and small caps," says Thomas of Emkay Wealth Management.

Mid-cap and small-cap stocks will become costly

As a result, a huge amount of money will now move to mid-cap and small-cap stocks. "The AUM of multi-cap funds is Rs 1.46 lakh cr.  The new allocation requirements will need AMCs to reallocate Rs 40,700 crore from large-cap stocks to mid-caps (Rs 13,000 cr) and small caps (Rs 27,700 cr). This will put tremendous buying pressure on small-cap counters," says Belapurkar of Morningstar India.

The indirect fallout of this move is that the demand for small-cap stocks will rise. "This move will help mid-cap and small-cap stocks to move up in the light of their share going up in terms of allocation," says Thomas of Emkay Wealth Management.

Also read: SEBI hikes minimum investment corpus in equities to 75% for multicap funds

How will it impact the fund management

Multi-cap funds have been performing well with large-cap heavy portfolio, which was delivering returns as much lesser risk. To generate a higher return than the large-cap benchmark, these funds used to invest in some select mid-cap and small-cap funds and this exposure was regularly changed based on changing equity market dynamics.

The first impact of the SEBI mandate is the flexibility, which a fund manager enjoyed to respond to different market scenarios, will be curtailed immensely. "Multi-cap funds stood out as they gave the fund managers complete agility to zero down on the market cap of their choice. He could make his selection based on the stock in which he saw potential and where valuations were not stretched. The only restriction was that 65 per cent of the portfolio must be in equity," says Belapurkar.

With 75 per cent of the investment being rigidly defined to be invested in three different categories, the fund manager will only have 25 per cent assets to be invested based on their discretion.

Also Read: How many MF schemes should you hold?

What should investors do

Multi-cap funds can no longer be taken as an alternative and a better version of large-cap funds. With greater exposure in mid and small-cap stocks, the volatility of the return will increase. Going forward, the ability of a fund manager to do well in mid and small stocks will be a big differentiator as to how successful a fund is.

"Investors will need to reassess their multi-cap fund exposures, depending on their desired allocations across the capitalisation curves. For instance, if an investor already has significant exposure to mid- and small-cap funds, having a multi-cap fund may not be a good fit anymore. Also, multi-cap funds that have an international allocation will not be able to increase it to more than 25% of the portfolio," says Belapurkar.

So if you were looking to increase exposure in mid and small-cap funds, it may make sense to stick to multi-cap funds. However, if you have the desired investment in mid and small-cap stocks, it'll be better to move to a good large-cap fund to maintain the product mix. If a multi-cap fund is giving higher return due to international exposure, reduce your exposure and move some investment into focused international funds.

Also read: SEBI's new margin rule to come into effect from Sep 1; all you need to know