Mumbai: The Securities and Exchange Board of India is reconsidering restrictions imposed on mutual funds’ equity investments that were blamed for exacerbating the slump in mid- and small-cap shares in 2018-19, three people familiar with the matter said. The capital market regulator has sought suggestions from mutual funds on how the existing share categorisation rules can be broadened, the people said.
Industry officials said many fund houses have recommended widening the scope for investments in large- and mid-cap shares, which would automatically shrink the small-cap space.
“Some more flexibility in the way large-caps and mid-caps are defined will give the industry a breathing space and reduce concentration risks also,” said one of the three people quoted above.
Sebi will take its decision on the basis of the industry’s inputs, the person said. An email query to Sebi in the matter went unanswered.
The move, if implemented, will give more flexibility to fund managers to switch between large- and mid-caps. It is also expected to improve liquidity for smaller stocks.
The capital market regulator has been under pressure from various sections of the broker-fund manager community for having made the rules restrictive. The rules were also blamed for the underperformance of equity mutual fund schemes till recently.
In 2017 October, the regulator had limited the kind of stocks mutual funds could invest in. Large-cap funds must invest at least 80 per cent of their total assets in the top 100 companies by market capitalisation. Mid-cap schemes have to invest 65 per cent of their corpus in companies ranked between 101 to 250 by market capitalisation while the small-cap schemes must put in 65 per cent of their assets in companies ranked beyond 250 in the market cap list. Sebi introduced these categories to force asset management companies to adhere to the investment mandate of the funds, which fund managers did not follow in the absence of a clear definition for stock categories.
Association of Mutual Funds in India updates the list of stocks in large-cap, mid-cap and small-cap categories every six months. The list is made before the end of the six-month period and funds get a month to realign their portfolios.
The introduction of the rules coincided with the sell-off in mid- and small-cap stocks starting January 2018. The decline in the shares deepened as fund managers shuffled holdings across schemes to meet the regulatory requirements. Many fund managers have been complaining that the narrower share categories have been too restrictive and have affected performance.
“The rules have been structured in such a way that money is flowing only into the top 250 stocks (by market cap). This has severely impacted the performance of large-cap schemes,” said the CEO of a mid-sized mutual fund, requesting anonymity.
Stock brokers are believed to have approached the government and the regulator seeking easier rules on the grounds that the sharp drop in mutual fund money flows beyond the top 250 stocks have virtually dried up activity in small-cap stocks, hindering their fund-raising capability.