India’s financial markets regulator – SEBI on 11 September 2020 came up with a mandate requiring all Multi-Cap mutual fund schemes to have minimum 25% of their Assets in Mid Cap Companies and 25% in Small Cap Companies. This makes 50% of the investment pool size to be invested in 50% Mid & Small size companies. The change is mandated to be done by Feb 2021.
If we try comparing the benchmark for a true Multi-Cap fund, this would NSE500 or BSE 500, where around 80% of the market capitalization is of Large Size Companies and balance 20% in Mid & Small Size Companies. By making the change in Multi-Cap funds based upon the new mandate, this will make the composition of such funds materially different from the benchmark, making them more volatile / riskier than the benchmark.
Dilemma of an investor
For an investor who would have bulk of their portfolio comprising of Multi-Cap funds, this would make their portfolio extremely skewed to the mid & small caps. Such investors may also be investing in separate Mid & Small Cap funds. This change in many cases could make the investor’s portfolio deviate materially from the risk appetite.
Dilemma of the markets
Actions within a Stock market are a combination of all participants. However, as an immediate after effects of this recent change, the new breed of #Robinhoodtraders in India may be doing their rapid mathematics. If Multi-Cap funds space is approx 1.5 lakh crore, of which 75,000 crore would need to be invested in Mid & Small Caps. If even half of it is going to be incremental flow, then this space is going to become really hot owing to demand from the ‘fund houses’. However, the fund houses may want to wait and watch. They may have extended deliberations with the regulator. But the #Robinhoodtraders would perhaps immediately start buying stocks in Mid & Small Cap space and push the prices of this ‘not-so-liquid’ stocks to the bubble zone. On the flip side, the mid / small cap stock portfolios will shine. But how long would this rally last ? My guess is as good as yours.
In addition, we may also see such traders to start dumping large cap names which have been the market darlings for a couple of years now. #puntergiri at its best
How Should An Investor React ?
Like in many cases, the best thing to do is not to do any thing. Also, the best thing to do is NOT TO FOLLOW the star ratings of the market research websites as these are more backward looking. The portfolios of the funds may change. We may see consolidation of a few funds to changing of the investment mandate to accommodate SEBI’s requirements. We may see no change at all if SEBI chooses to reconsider.
One must ensure that their portfolios continue to remain balanced and it is here where composition of the portfolio and its volatility (a.k.a. the risk) is managed. It is sad but true, most investors would only care to look into the returns generated in the past and may get impacted. The future may be slightly to very different and hence watch the space in this category. It is best to consult your financial advisor.
What Are We Doing ?
We are closely watching the space and attending all fund management calls to understand their future portfolio constructs. There is no immediate change which may be done by us as the change would be effected by February 2021. However, as and when the situation unfolds, we would inform our clients of the changes required in their portfolio constructs to suit their long term requirements. These could range from identifying alternative options to making a reduction in any other source of Mid / Small cap exposures such that the overall portfolio remains balanced.
We would like to end this note by saying that such changes will continue to come and go. Each such change could come with interesting market reactions. However, in the longer term, the returns on a portfolio are more dependent upon the growth and profitability of the underlying companies. If we get this thing right, the short term changes will be more of a noise.