SEBI recently announced major changes in structuring of multi-cap fund portfolios. While it created a lot of excitement among retail investors, fund managers were worried about the practical application of the rule. These 10 questions and responses will demystify the new multi-cap fund rule.
What exactly has SEBI stipulated about multi-cap funds?
SEBI has made two key changes to multi-cap fund regulations. Multi caps will have to invest, at least, 75% of their corpus in equity and equity related instruments compared to just 65% in the past. Secondly, multi-cap funds must invest at least 25% of the corpus in large caps, mid caps and small caps respectively. The last 25% can be allocated at the discretion of the fund manager.
How do mutual funds define large cap, mid caps and small caps?
These classifications have been defined by SEBI back in 2017. Every six months, all the listed stocks are indexed based on their average market cap on BSE and NSE. The top-100 stocks in this ranking are classified as Large Cap stocks, the next 150 as mid-cap stocks and all others are classified as small caps. Here is the link to the updated list on AMFI. https://tinyurl.com/y4nqdhab
This list changes every 6 months in June-end and December-end.
Are multi-cap funds big enough to make a difference?
Multi-cap funds have emerged as a viable alternative to large cap funds since they combine the stability of large cap stocks with the alpha potential of smaller stocks. In India, multi-cap funds have grown, as a category, in last five years. The current assets AUM of multi-cap funds in India are Rs147,000cr.
Why does SEBI want to regulate the portfolio mix of multi-cap funds?
Back in 2017, SEBI had asked MFs to reclassify their funds so that the nomenclature is “True to Label”. SEBI observed that multi-cap funds had average exposure of 65% to large caps, just 16% to mid caps and 10% to small caps. SEBI also found specific cases where large caps constituted 80% of the portfolio and there were no small caps. That defeated the purpose of multi-cap funds as funds were not true-to-label.
Will this lead to huge MF flows into mid and small cap stocks?
There is a technical side and a practical side. Technically, if the average multi-cap composition has to be brought to 25:25:25, it will entail selling Rs40,000cr from large cap portfolios and buying Rs16,000cr in mid cap and Rs24,000cr in small cap portfolios. On paper; it will surely create a huge demand for mid cap and small caps stocks.
However, there is a practical side to it. Mid-caps and, especially, small caps are extremely illiquid. Any large purchase would not only spike the price but also impose higher impact costs on the fund. That is the reason, SEBI has issued a clarification to their original multi-cap order.
Are returns on multi-cap funds better than large cap funds?
Not exactly; if you look at the Morningstar analysis! Over last 5 years, large cap funds gave CAGR returns of 7.88% compared to 7.49% for multi-caps. Over a 10-year period, large caps yielded 8.01% while multi-caps yielded 8.51%. On risk parameters; Beta and index correlation of multi-cap stocks is more than that of large caps. SEBI is right as there is not much for investors to choose between large caps and multi-cap funds.
Do you see some of the multi-cap funds returning money to their clients?
That possibility cannot be ruled out. The new rules would make it tough for smaller multi-cap funds with a corpus of less than Rs1000cr to sustain. It would be very hard to split small funds between large caps, mid caps and small caps. It is perfectly likely that some of the multi-cap funds may choose to refund monies to investors.
Will mutual funds look to merge multi cap funds with other categories?
SEBI and AMFI have highlighted this option. For example, there is a category called Large and Mid-Cap Funds, which is more flexible in terms of the mix and multi cap funds may either be converted into or merged into such funds. Another option is to do an inter-scheme transfer of stocks into mid cap and large cap funds to attain the balance in multi-cap funds.
Can multi-cap funds be converted into thematic funds?
That is one more option available. As per AMFI, multi-cap funds can select a set of themes that encompass the entire multi-cap portfolio. These can be themes like rate sensitives, ESG, commodities etc. There are no limits on the number of funds an AMC can have in sectoral and thematic categories. However, fund managers are wary of thematic funds as they are perceived as potentially high-risk investments.
Will the new rules on multi-cap funds be effectively immediately?
SEBI has already clarified that the new multi-cap rules will only be effective from February 2021. Multi-cap funds and its investors have time till end of Jan-21 to take a final view on the subject.