SEBI pokes multicap funds – What should you not do?

On Sept 11, 2020 (yes, 9/11), SEBI issued a circular redefining market cap exposure limits for multicap funds.

SEBI now wants multicap funds to adhere to a structure where it invests minimum 25% each in large, mid and small caps. The balance 25% can be invested anywhere.

This is in a departure from the status so far where multicap funds are expected to invest anywhere they want. They operate like flexicap funds.

In reality though, most multicap funds, in the last few years, operated like large cap funds with 70% or more exposure.

SEBI’s contention is that they are large cap funds in disguise. Essentially, they are running 2 large cap funds, one here and one under the large cap category.

Hence, the SEBI’s move hoping that this will make the multicap funds more true-to-label (a term that has been bandied about for making a fund investor’s life easier). If you invest in multicap funds, from year 2021, you can expect to have the right flavour of large, mid and small.

Will the multicap funds be able to do that?

That’s the real issue here. You see, the largest multicap funds are the size of elephants in context of India stock markets.

If a multi cap fund with a size of Rs. 30,000 crores decides to move 25% of its corpus to small cap funds, that’s about Rs. 7,500 crores. Assuming it already has Rs. 3,000 crores in small caps, an additional Rs. 4,500 crores needs to move.

If you give a factor of 3 to count for the industry, we are talking several thousand crores.

Are there enough small cap opportunities to take such inflows? I seriously doubt that.

Then there is the movement to mid caps – remember 25% of the assets need to be there too.

Funds will be forced to invest in every company in the small cap space to comply with the SEBI norm and it could put investor’s interest at risk with illiquid small caps hogging the portfolio.

I don’t see the funds being able to comply fully.

So, what is going to happen?

Frankly, that is yet to be known. However, mutual funds have options to consider (as confirmed by SEBI as well as communicated by fund houses in their communication to us investors).

Option 1: Change the category of the fund itself.

Yes. The multicap fund can change its fund category and sidestep the requirements neatly. This will be a popular option for the smaller fund houses such as PPFAS and Motilal Oswal. These fund houses have not filled up every category provided by SEBI.

Parag Parikh Long Term Equity Fund could just shift itself to the value / focused category and job done. It gets to keep the spirit of the fund intact.

Motilal Oswal Multicap 35 can do a similar thing as well.

There is nothing that you need to do if this happens.

Fund houses like HDFC, ICICI Pre, Kotak, Aditya Birla, Axis will have some hard thinking to do. They don’t have categories left per se (except if they look at the thematic category which allows unlimited launched). So, they may choose the next best option.

Option 2: Merge it with another fund, say a large and mid cap fund

As I mentioned, the larger fund houses such as HDFC, ICICI Pru, Aditya Birla and Kotak have their shelves full. So, they are likely to take the next best option – merge with one of their existing funds.

Can Kotak Standard Multicap could merge with Kotak Equity Opportunities fund (the large & mid cap category fund)?

What if HDFC Equity Fund were to merge with HDFC Top 100 and together become a large cap category offering? Eh, even the fund manager is the same.

Of course, this changes the fund profile but may be not significantly enough. You will need to evaluate if your portfolio is okay with such change and take a call accordingly.

Option 3: Stay put and change market exposures of the fund in line with the circular.

Well, the final option. The fund could just go ahead and comply with the circular and invest min of 25% each in large, mid and small cap.

As far as you, the investor, is concerned, you are now looking at a forced increase in risk profile of a fund that you are invested in.

While the multicap fund has the mandate to take such an exposure, the idea was to do it when the opportunities are really in favour. SEBI circular makes it a forced one.

And your portfolio may not need the additional dose of mid and small caps.

What should you do now?

Frankly, as of now you should do nothing.

One, fund houses are yet to decide which of the paths are they going to take. Mutual funds are getting ready to make presentations to SEBI about the new circular and are hoping to get some concessions.

Two, SEBI has given a timeline till Jan 31, 2021 to comply with the new circular. Fund houses, before they make a change, will give enough warning to you as investors and you can accordingly decide the course of action.

So, please wait for now.

What should you NOT do now?

There are several murmurs about how this rejig in multicap funds is going to give a boost to mid and small cap stocks and funds. I have been asked if this is a good time to increase exposure to such funds / stocks and participate in a likely rally.

I say NO. This is a speculative stance.

You might already have mid and small cap funds. If such a thing happens, they will automatically benefit. Who knows if there is an actual rally, you may have to alter your allocation downwards than upwards.

Don’t alter your risk profile for short term gains and for a series of events we don’t even know how it will play out. There is many a slip between the cup and the lip.

Stay aligned to you risk profile and asset allocation. Consider the communication that will come through in the next few weeks and decide accordingly.

Note: SBI small cap recently closed down lump sum investments and limited new SIPs to Rs. 5,000 per month per PAN.

Also, for funds in the Insider recommendations and advisory clients, we will let you know of the relevant actions as and when there is clarity from fund houses.