Published on – 15-September-2020

Say you are a young investor and plan to begin an investing in Mutual Funds with a SIP of 1,000 monthly. Because of the small size of SIP, you are likely to buy a diversified portfolio. You choose a Multi-Cap Fund but later it turns out that despite claiming to be Multi-Cap, it was primarily holding large cap stocks.

In another case, you want to invest 1 Crore and not sure of market cap allocation, you choose a Multi-Cap Fund assuming it is diversified across Market Cap and the same is reflected when you observe its holding portfolio. Over the next six months the fund tilts the investment towards large cap as high as 90%. For some reasons, the next two years broader market outperforms large cap peer and your fund under performs with respect to the broader markets. You feel disappointed knowing your fund had 90% exposure in large cap stocks.

This scenario is even more precarious when it comes to debt where you buy a short-term fund and find out one morning that your fund lost 5% NAV due to a default by a low rated company’s debt in the portfolio.

SEBI’s rejig of Multi Cap Funds is another advancement to make Fund names true to the label by asking Mutual Funds to allocate 25% each to Large Cap, Mid Cap & Small Cap mandatorily. The equal weight-age mandate may be subject to debate but the action itself is prudent and should lead to clarity for investors.

There is an argument that Small caps makes only ~10% of total free float market capitalization of Indian Equities and it is not feasible to reallocate the corpus from Multi Cap Funds to Small cap funds in the manner mandated by SEBI. The total small cap free float market cap is ~7 Lacs crore, there will be an incremental flow of 27k crore as a result of such reshuffling. It is ~4% incremental flow but certainly not likely to be equally distributed among all small cap stocks and second the impact cost is pretty high in small cap category. Given such context, the argument holds valid, but this cannot be an impediment in structuring Multi-Cap funds true to the label. There must be some innovative solutions to this paradox.

SEBI in the next press release suggested the options available with the AMCs to comply with the circular. Below we analyse a few of the mechanisms from an AMC’s point of view –

  1. Facilitate switch to other schemes by Unit Holders – The unit holders given this choice may like to evaluate the merits of target scheme and the peers too, but this looks like a feasible option.
  2. Merge with other Large Cap Fund – This action will wipe out the performance track record and the brand name of the existing scheme. Feasible option only for a low AUM and recently launched schemes.
  3. Convert the Multi Cap Scheme to other category Scheme – This will only change the label and will keep other attributes as it is.

Now whatever action the fund houses take, a restructured category of Multi cap is coming into being, and this time with defined market cap allocation. This is where Investment Advisors must play a pivotal role, as the asset allocation up to the level of market cap assignment falls in the purview of adviser largely going forward.

What actions AMC’s take will get clear in coming weeks. How much money actually reshuffles towards Mid & Small caps category remains a question to watch for. What would be the impact of such shift on the broader markets is also something to watch out for.

What investors should figure out is the asset allocation which works for them and should stick to it.

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