The markets regulator on Sunday outlined the options available to fund managers to comply with rules on how investments should be spread across assets even as the industry raised apprehensions about the challenges in implementing the new portfolio rebalancing norms for multi-cap funds.
The Securities and Exchange Board of India (Sebi) said it will examine proposals by the industry to ensure managers of multi-cap funds stick to the mandate of investing substantially across a wide section of firms.
“Apart from rebalancing their portfolio in multi-cap schemes, they could inter-alia facilitate a switch to other schemes by unitholders, merge multi-cap scheme with large-cap scheme or convert multi-cap scheme to another scheme category, for instance, large cum mid-cap scheme,” Sebi said in a note.
On Friday, Sebi directed multi-cap funds, the portfolio of which are dominated by large-cap stocks, to keep at least 25% of their assets each in large-, mid- and small-caps by 31 January. Fund managers said a strict reassignment of assets could trigger massive inflows into mid- and small-cap stocks, reducing the market skew towards large-cap stocks.
“Sebi is conscious of market stability and, therefore, has given time to the mutual funds till 31 January to achieve compliance with the circular, through its preferred route of which rebalancing of the portfolio is only one such route,” the regulator added.
Amfi welcomed Sebi’s clarification on asset allocation to multi-cap schemes on Sunday and said the industry is committed to following regulations in letter as well as spirit. Amfi will gather feedback from members and revert for non-disruptive execution of multi cap funds portfolio balancing.
Fund managers are planning to petition the regulator about the challenges in implementing the new rules, even as they work to avoid large-scale disruption and keep investors satisfied.
“The Association of Mutual Funds in India (Amfi) will be making a representation to Sebi about the execution challenge of the multi-cap circular. We are in discussions with members to formulate representation,” an Amfi member said. Fund managers will not buy small- and mid-cap stocks just because there is a circular, this person added on condition of anonymity.
The mutual fund industry has other options, a top executive at a large fund said. “Alternatives are to merge schemes (multi-cap with large mid-category), change scheme category from multi-cap to flexi-cap, or create a new category of funds so that there is no compromise to investors,” the person said.
The rally following the March crash has inflated the valuations of most mid- and small-cap stocks, leaving little choice for fund managers.
From March lows, the BSE Smallcap index has rallied 64% and the BSE Midcap 51%, outpacing the Sensex, which has gained 50%. In 2017, both BSE Smallcap and BSE Midcap indices rallied 60% and 48%, respectively, leading to losses in the following years as stocks with little fundamental support lost steam amid high valuations. At current levels, BSE Midcap is available at 12-month forward price-earnings (PE) ratio of 21.75 times, BSE SmallCap at 18.69 while the Sensex is at 21.29 times.
Kotak Standard Multicap fund with ₹29,714 crore assets is India’s largest multi-cap fund. “Current allocation of Kotak Standard Multicap fund is large-cap biased from a risk-reward point of view. Impact cost, quality of balance sheet and governance practices weigh in favour of large-cap stocks at this point of time from the risk-reward point of view,” said Nilesh Shah, president and managing director, Kotak Mahindra AMC, in an investor call. According to Morningstar India data, its exposure to large-cap stocks was 78.4%, mid-cap 18.4% and 1.2% in small-cap funds in August.
Some options the fund is considering include returning money to clients, seeking a switch to other funds with help of partners, merging multi-cap fund with large-cap or large- and mid-cap funds to maintain investment process and portfolio quality and converting multi-cap fund to thematic fund like ESG fund to maintain investment process, said the chief executive of another large fund house.
Neil Borate contributed to the story.