Early Diwali for Mid & Small Cap stocks? Learn more on SEBI’s new norms on Multi Cap Mutual Funds

We all know, Mutual Funds are categorized as equity funds and Debt Funds. Further there is classification on the basis of stocks into which a mutual fund invests, e.g. Large cap mutual fund which invest predominantly (min 85%) into Large Cap.

If you are new to mutual funds, read our article on “What is Mutual Fund”. Click on the text to read more.

 Click here to know more on “Systematic Investment Plan” (SIP)

 A Multi-cap Mutual fund scheme can invest a minimum of 65% of total assets across large, mid and small cap stocks. At present, fund managers of multi cap funds can invest across market capitalization as per their choice, which mean they can invest this money entirely in either large cap or mid cap or small cap stocks

However, this is about to change, because of SEBI’s new guidelines on Asset Allocation of Multi-cap Mutual Funds

Check out SEBI’s circular on Asset Allocation of Multi Cap Funds

These rules will come in effect from January 2021.

Appended are rules mentioned in the circular:-

Minimum allowed investment in equity & equity related instruments should be 75% of total asset under management. Currently mutual funds are required to invest a minimum of 65% in equities.

Minimum investment in equity and equity related instruments has to be done in the following manner:

• 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
• Minimum investment in equity & equity related instruments of small cap companies: 25% of total assets

Note, Mid Cap stocks: 101st -250th company in terms of market capitalization &

Small Cap stocks: 251st company onwards in terms of market capitalization

Now let’s see, how this new norms will change the existing investment pattern for multi cap funds. Let’s take example of UTI equity Fund. This is a “5 star” mutual fund and has a AUM of almost ₹ 11,000 Crores. Presently UTI Growth Fund has invested only 8% of its AUM into Small Caps. As per SEBI’s circular, it has to invest 25% in small caps. Back of the envelope calculation shows UTI Equity Fund alone have to invest ₹ 1850 Crores in small caps. This can be HUGE for mid caps. Same will be applicable for mid caps if we study investments of all multi cap funds.

source : moneycontrol

As per CNBC, small & mid cap stocks may see inflow of ₹ 35,000 Crores, Read CNBC Awaz take on these norms here in this video, 

If these much of money is to be channeled in small and mid cap stocks in matter of 4 months, many stocks may become multibaggers. The recent rally in market is mostly driven by large caps like Reliance Industries, so this circular may bring fresh investments, which in turn propel stock prices and we may see good returns in quality small and mid cap funds in coming days.

Now, coming back to the SEBI circular. It takes away flexibility of mutual funds managers to invest as per market situation and will force them to stay invested in mid caps and small caps irrespective of performance and/or market conditions.

According to Value Research, the multi cap fund category has currently an average exposure of around 70% of the portfolio in giant & large cap stocks, 22.42% in mid cap stocks, and 8.34% in small cap stocks. Since now, multi cap funds will force to reshuffle their portfolio, the risk profile of such schemes will obviously increase many folds (as can be evident of example of UTI Mutual fund above)

However, SEBI has tried to put some of these concerns to rest by issuing clarification on Sunday 13th Sept 2020. It reads as below

"SEBI would like to clarify that mutual funds have many options to meet with the requirements of the circular, based on the preference of their unit-holders. Apart from re-balancing their portfolio in the multi cap schemes, they could inter-alia facilitate switch to other schemes by unit-holders, merge their multi cap scheme with their large cap scheme or convert their multi cap scheme to another scheme category, for instance large cum mid cap scheme"