Just saw this circular which sets a mandatory requirement on multi cap funds to invest a minimum of 25% each in large, mid and small caps. How will this change the category and what does it mean for investors.
This is a pretty huge move that can have some really big impact on the markets. To set some context, in 2017, SEBI had re-categorized all mutual fund categories and strictly defined that universe of stocks by that funds could invest in.
As per categorization, this was the mandate for multi cap funds:
Minimum investment in equity & equity related instruments- 65% of total assets
Investors like this category because it could invest anywhere across large, mid, and small caps based on the the fund managers view. And they were quite popular too. It’s the 2nd biggest equity fund category with, 1.47 lakh crores of AUM.
| Category | AAUM in Crs (Aug, 20) |
|---|---|
| Multi Cap Fund | 1,46,708.38 |
| Large Cap Fund | 1,49,177.02 |
| Large & Mid Cap Fund | 57,509.08 |
| Mid Cap Fund | 88,052.48 |
| Small Cap Fund | 50,935.99 |
| Dividend Yield Fund | 4,228.93 |
| Value Fund/Contra Fund | 53,441.50 |
| Focused Fund | 52,771.96 |
| Sectoral/Thematic Funds | 65,694.39 |
| ELSS | 98,171.63 |
But you will also have to remember that the Indian markets are still small in the grand scheme of things. Mid and small-cap stocks still suffer from liquidity issues. As multi-cap funds became larger, they ended up essentially becoming large cap funds. Across the category the average large cap exposure was well over 70% according to Value Research and the remaining 30% in mid and small caps.
The category average expense ratio of multi caps funds was between 1-1.5% and it didn’t make sense to allocate to this category hoping to get small and mid cap exposure when these multi cap funds were largely substitutes for large caps funds. A Nifty 50 ETF or an index fund which is a large cap fund was available for 0.10%
Today, SEBI published a new circular setting minimum investment limits in large, mid, and small cap stocks for multi cap funds. This is a dramatic move.
Minimum investment in equity & equity related instruments of large cap companies-25% of total assets
Minimum investment in equity & equity related instruments of mid cap companies -25% of total assets
Minimuminvestmentinequity& equity related instruments of smallcap companies -25% of total assets
Now what this means is that, at the minimum, 50% of the multi-cap AUM has to be invested on small and mid caps. The 10 biggest funds pretty much account for most of the category AUM.
This has to be done by Feb 2021:
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.
| Fund | AUM |
|---|---|
| Kotak Standard Multicap Fund | 29,714.07 |
| HDFC Equity Fund | 19,797.98 |
| Motilal Oswal Multicap 35 Fund | 11,239.87 |
| Aditya Birla Sun Life Equity Fund | 11,023.35 |
| UTI Equity Fund | 10,982.95 |
| SBI Magnum MultiCap Fund | 9,063.31 |
| Franklin India Equity Fund | 8,591.33 |
| Nippon India Multicap Fund | 7,501.44 |
| Axis Multicap Fund | 6,275.36 |
| ICICI Prudential Multicap Fund | 5,355.45 |
Impact
A fund like Kotak multi cap which has 30,000crs in AUM. 70% of it’s AUM is in large caps and 30% in mid caps. At a minimum has to sell 20% of its large cap portfolio, that’s over Rs 4000 crs and Rs 400 crs of mid-caps and move it to small-caps,
Here’s the SEBI definition of large, mid and small caps:
Large Cap: 1st -100th company in terms of full market capitalization
Mid Cap: 101st -250th company in terms of full market capitalization
Small Cap: 251st company onwards in terms of full market capitalization
There’s going to be a lot of large and mid cap selling and rotation into small caps. There are valid concerns of the small caps can handle this amount of fresh liquidity. This may cause some serious price moves in small cap stocks.
This will also lead to the multi cap category becoming a little less attractive for investors, advisers, and distributors. This could potentially lead to outflows from multi cap categories to large-cap funds or even focussed funds which can still invest anywhere but can only hold a maximum of 30 stocks.
The other impact of the move is that funds can now only invest 25% of the AUM in international stocks. A fund like Parag Parikh Long Term Equity Fund can invest up to 35% of it’s AUM in international stocks.
It remains to be seen as to how the industry will react to this. There’s a lot of conjecture in the heat of the moment but will keep the thread updated as and when there is more clarity.
Update - Septemebr 13th, 2020.
Predictably, this created a lot of concern among AMCs. There’s been a loud debate as to what the AMCs are going to do and justifiably so. This is expected to lead to a 25,000cr+ shift into small cap stocks. Here’s an estimate from ICICI, assuming all things equal.
Several AMCs have told investors that they aren’t going to buy small caps if doesn’t make sense and they would rather explore other options like:
- Changing the scheme mandate to thematic funds, large and mid-cap funds, focussed funds etc. Focussed funds and thematic funds don’t have category restrictions and they can go invest anywhere. Focussed funds can only hold a maximum of 30 stocks. Given that multi-cap funds largely held only large and mid caps, they could be converted to large and mid cap schemes or merged if an AMC has an exisiting scheme.
- Merge multi cap funds with existing large and mid cap schemes.
- Shut down the scheme and return the money to investors. Although some AMCs have mentioned this, I think it is just rhetoric, they’ll find a way to fit these schemes elsewhere.
Given all the noise, SEBI just issued a press release clarifying the reason behind the circular. Here’s an excerpt from the release
Multi Cap schemes had flexibility in terms of allocation to Large, Mid and Small Cap stocks. However, it has recently been observed that some Multi Cap Schemes have skewed portfolios, with over 80% of investment in large cap stocks akin to Large Cap schemes, and some Multi Cap schemes have near zero or insignificant asset allocation to small cap companies.
Considering the above, in order to achieve the objectives of True to Label and Appropriate Benchmark, a need was felt to review the scheme characteristics of Multi Cap schemes and take necessary steps to clearly distinguish Multi Cap schemes from other category of schemes.
Update - November 6th, 2020
SEBI just issued a circular announcing the creation of a new category called Flexi Cap Fund. Funds in this category can invest across large cap, mid cap, and small cap stocks in any proportion they choose. This is the same as the old multi cap fund category guidelines. Now all the funds which had a higher allocation to large cap stocks but didn’t want to invest in mid and small cap stocks can recategorize themselves as Flexi Cap funds. This essentially means that all there won’t be a large flow of money into mid and small cap stocks. The larger funds might just change the fund manage to a flexi cap fund to avoid the mandatory investment limit in mid and small cap stocks post the circular.
What this means to you as an investor?
If a fund is recategorized as a flexi cap fund, the AMC will give you a 1-month exit load free window if you wish to exit. Remember, If you are exiting a fund, only exit load won’t be applicable during this window but all the tax implications will still be applicable.
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This move will ensure some uniformity across the investment industry, and should be welcomed.
The regulators appear to be preventing what is happening in the US markets - a few Apples and Amazons are tilting the whole game of the market. Even in NIFTY of India, the top 6-7 companies account for almost 50% weight of NIFTY, and rest 44 companies account for the remaining 50%.
Since MFs/IFs/ETFs follow benchmark indexes, most of which are market-cap driven, the bulk of weight is given to a few large caps forcing more buying in these few stocks. This anomaly is skewing the investments.
This move by SEBI will bring temporary volatility to the market, but should be a welcome move for long term benefits as it will harmonize the spread of investments, and will unify the various market segments to a great extent.
Nice perspective
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This update will make the fund managers less flexible with their decisions.
Although this makes the Multicap category true to its name, but looking into it from another way, the fund managers in this category earlier had a flexibility to invest however they like across all the categories, each fund managers of Multicap fund were specialized to handle the money with that flexibility, now things will be different when they will be under mandate to allocate 50% of assets to mid&small cap, this will take things to another perspective and existing fund mangers of multicap schemes may fail to give the consistent returns as earlier, because of the limited flexibility which might affect their style of investing.
However one concern that came up about selling pressure that might be created from the selling of large caps (because most of the existing multicap funds have around 70% of its allocation in large caps, and in order to comply they may need to sell of), that will be a highly unlikely case. The more possible scenario would be to change to a different scheme of funds.
What would be the future for MultiCap Schemes ?
New schemes might be started which would comply with the new mandates, however it does not makes sense to re-allocate an existing fund portfolio with the new norms. Moreover, in future more than one Fund Managers might be needed to handle a multi cap fund bcoz of the amount of diversification it requires under new norms.
As per news, AMFI has requested SEBI to bring a new fund category - FlexiCap, which (as the name suggests) might provide fund managers the flexibility as the current Multicap norms provide.
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