Investment

New Sebi norms will make multi cap schemes risky. What should you do?

The new Sebi norms will make multi cap mutual fund schemes riskier than they are now. According to the new norms, multi cap schemes are mandated to invest 75% of the total assets equally divided between stocks in three market capitalisations. In other words, multi cap schemes should invest at least 25% each in large-, mid-, small-cap stocks.

“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,” said a Sebi circular released on Friday evening.

Currently, multi cap schemes have the freedom to invest across sectors and market capitalisations based on the outlook of the fund manager. The new norms will take away this flexibility. It will also force fund managers to stay invested irrespective of the performance of the stocks in a certain market capitalisation.

In practice, most of these schemes are invested mostly in giant, large cap, mid cap stocks. Most schemes have very small exposure to small cap stocks.

According to Value Research, a mutual fund tracking firm, the multi cap category has an average exposure of around 52.41% of the portfolio in giant stocks, 17.47% in large cap stocks, 22.42% in mid cap stocks, and 8.34% in small cap stocks. New

According to Kaustubh Belapurkar, director (research), Morningstar India, “This move will require shuffling of multi cap fund portfolios from asset managers. About Rs 27,000 crore will move to small cap stocks and Rs 13,000 crore to mid-cap stocks,” he says. For more, read: Sebi tightens investments norms for multi cap funds, evokes protests

Let us look at the portfolio composition of some of the prominent schemes in the multi cap category. Parag Parikh Long Term Equity Fund, the topper in the three- and five-year horizons, has around 52% of the portfolio in giant stocks, around 11% in large cap stocks, 23% in mid cap stocks, and around 12% in small cap stocks.

Kotak Standard Multi Cap Fund, the largest scheme in the multi cap category, has very little investments in small cap stocks (0.30%). The scheme is mostly invested in giant (53.78%), large cap (17.90%), and mid cap (28.02%) stocks.

HDFC Equity Fund, a seasoned fund in the multi cap category, also has most of its portfolio in giant (50.72%) and large cap (33.33%) stocks. It also has small investments in mid cap (11.89%), and small cap (3.99%) stocks.

As you can see from Belapurkar’s statement and the portfolio composition of these prominent schemes, most multi cap schemes will have to increase their exposure to small cap stocks drastically. Some schemes also need to add more mid cap stocks to their portfolios.

If your scheme has been following an investment strategy of investing mostly in large cap stocks with a little exposure to mid cap stocks, it may face a very big challenge of increasing and managing its investments in small cap stocks. Investing in small caps is considered specialists’ job in India because of the quality of management and governance in the small cap universe. Only a few fund managers managed to post consistent performance in the small cap space.

Mutual fund analysts believe that some mutual funds may try to change their fundamental attributes to evade the new norms. They believe funds may label themselves as focused funds. Focused funds have the mandate to invest in a maximum of up to 30 stocks. This again can enhance risk if the scheme is currently managed with a very large diversified portfolio.

Some analysts also believe that some schemes like Parag Parikh Long Term Equity Fund can categorize itself as a value fund and escape the new norm. However, Neil Parikh, CEO of the fund house, said, “Our team has examined the circular. We believe that there are options available to us which can enable our fund to function with the existing mandate.”

“Will be discussing these with our board / trustees / SEBI and AMFI. We will not be in a position to comment on the prospective measures till all approvals are in place. Thank you for your patience. Rest assured that we will have the best interests of unitholders in mind,” he tweeted.

Finally, what should be your plan of action? As of now, do not do anything. Wait and watch what the mutual fund industry is going to do about it. More importantly, how your scheme is going to tackle the issue. Only when there is a clear scenario, you should try to act.

Scenario 1

The fund decides to comply with the new norms
What it means and what you can do: It increases the risk and takes away the flexibility. If you are confident about the fund manager, you may give him or her a year or two to perform. If you are uncomfortable with the extra risk, you may consider shifting to a scheme with lower risk. For example, if you are uncomfortable with the exposure to small cap stocks, you may consider investing in large & mid cap schemes.

Scenario 2

The scheme reclassify itself as focused fund or a theme like value

If the scheme always had a concentrated portfolio, you don’t have anything to worry if it labels itself as a focused fund. However, if the scheme used to have a very large diversified portfolio, you should be careful. It is not easy to run a concentrated portfolio with high-conviction bets.

Similarly, if a scheme labels itself as a value fund, you have nothing to worry if it always used to follow the value investing principles. For example, PPFAS Mutual Fund always emphasizes value investing principles. So, investors have nothing to worry about if it becomes a value fund.

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