SEBI’s new multi-cap fund rule: What lies ahead?

Do you remember celebrating any festival as a child? Be it Diwali, Eid, Rakshabandhan, Holi, absolutely any festival, one thing you were sure to receive as a child, apart from new clothes and sweets, was money. And you'd probably lie to yourself if you say that this was something you weren't the most excited about. Some of us liked to collect and store it in our piggy banks, and the rest would immediately set out to spend it. And since it was the money that was completely ours, we didn't need to seek any permission from our elders as to where and how we could spend it; well, usually.

Suppose you received Rs 100 as a gift on Diwali. You plan on buying a beautiful but expensive kite, which costs Rs 40. Then you decide to spend Rs 20 on sweets and chocolates and the remaining Rs 40 on buying a pencil box. Fund management, right? Now imagine your mother puts a limit on your spending and asks you not to spend more than Rs 30 on the kite and spend more on the pencil box and similarly limits your spending on the chocolates and sweets. What do you do now?

A similar situation was put forth by the Securities and Exchange Board of India (SEBI) in front of the Indian investors. On September 11, SEBI decided to limit the investments in the multi-cap equity mutual funds, which will significantly change the Indian investment practices.

What does the new SEBI multi cap fund rule say?

The Securities and Exchange Board of India (SEBI) on September 11 issued new guidelines asking multi-cap funds to invest at least 25% of their total assets, each in small-caps, mid-caps, and large-cap stocks, leaving the remaining 25% to their choice of investment. According to the new norms, these funds should have at least 75% of its asset allocation in equity and equity-related investments at any point in time as compared to the current 65% requirement. 

Earlier, multi-cap funds used to invest around 70-80% in large-cap stocks. With the motive of keeping multi-cap funding true to its name, this value was restricted to just 25% with SEBI's new multi-cap fund rule. The mutual funds have been given a time period of 4 months to comply with the new set of guidelines.

These new norms were introduced with the motive of motivating a fair influx of money in all the three categories of stocks, be it large, mid or small. Ideally, a multi-cap should have a representation of all cap stocks, which were mostly large-cap until now.

On September 13, SEBI clarified that mutual funds are free to choose the route for complying with the revised norms on multi-cap funds.

According to SEBI's statement, "Apart from rebalancing their portfolio in the Multi-Cap schemes, mutual funds could inter-alia facilitate switching to other schemes by unitholders, merge their Multi-Cap scheme with their Large Cap scheme or convert their Multi-Cap scheme to another scheme category."

This clarification might help mutual funds look at options such as merging multi-cap funds into large and mid-cap schemes or converting the existing product into thematic schemes. 

However, due to the recent ruckus created after the announcement of SEBI's multi-cap fund rules, the regulatory authority said on September 14 that "mutual funds should be true to its label and stick to appropriate benchmarking, indicating its seriousness to implement the circular strictly."

Effects of SEBI’s Multi-cap fund rules

The major effect of SEBI's multi-cap fund rules will be on the multi-cap funds, which had, up until now, been majorly investing in the large-cap stocks. Experts say that some multi-cap funds would invest up to as high as 70-80% of funds in large-cap stocks and the remaining in stocks of the small-cap and mid-cap companies, while some leading firms went even higher to the extent of 85-90%, thus, leaving very little for the small-cap and mid-cap stocks.

However, the new guidelines will now force these funds to limit a big part of their large-cap investment and move their funds in mid and small-cap stocks. This means that there will be a large movement of investments into the mid-caps and small caps.

Experts say that this shift in multi-cap funds can lead to about Rs 25,000 crores moving into small-cap companies and about Rs 10,000 crores into midcaps companies. They have also predicted that there will be select firms in these categories which will get the maximum allocation as a result of the new rule.

Since a huge amount of money will now be flowing into the small caps and mid-caps, their stocks' demand might rise. According to experts, "This move will help mid-cap and small-cap stocks to move up in the light of their share going up in terms of allocation."

This will eventually lead to an increase in the prices of mid-cap and small-cap stocks.

Impact on fund management

The new SEBI multi-cap fund rules will majorly impact the fund managers who previously had the flexibility to allocate funds in accordance with the ever-changing market dynamics.

Multi-cap funds gave fund managers the liberty to choose the market cap they felt best in terms of the on-going equity market situation. The fund managers had the freedom to invest across different industries and market caps based on their personal outlooks. The only restriction was that 65% of the portfolio had to be in equity.

SEBI's multi-cap fund rules have now taken away this flexibility of choosing the allocation of funds. With 75% of funds having to be allocated strictly in all the three market caps, the fund managers will now have only 25% of the funds to their own discretion. The new rules will also force them to stay invested in the stocks irrespective of their market capitalization performance.

The major challenge will be the movement and increase of funds into the small caps and their management if the previous investment strategy avoided small caps and focused majorly on the large caps. Until now, only a handful of fund managers have been able to post consistent performance in the small caps.

How will SEBI's Multi-cap fund rule impact you as an investor?

The new set of SEBI's multi-cap fund rules might change the face of the market cap equity investments forever. These new rules will increase exposure to the mid-cap and small-cap stocks, which might increase the volatility of returns on stocks. Multi-cap funds can no longer be considered as an alternative to large-cap funds.

Henceforth, a fund manager's ability to assess and perform well with mid-cap and small-cap stocks will be a major factor that will determine the success of a multi-cap fund. Depending on their desired fund allocation across various sectors of market capitalization, investors will now have to reassess their exposure to multi-cap funds.

If, as an investor, you had previously planned to explore the mid-cap and small-cap funds, multi-cap funds may be a good idea now. However, if you already have investments in the mid-caps and small caps, and you wish to retain a healthy mix, you can choose to move towards large-cap investments.

Conclusion

Going forward, with the new set of SEBI's multi-cap fund rules, both the investors, as well as fund managers will have to be extremely selective and careful in identifying good stocks.

For now, we can simply sit back and observe what the mutual fund companies are planning to go about in this new era of investing. It is better to plan things out, though.

So, just as your festival allowance, hold on tight to your money, analyze the market and opportunities, and carefully lay down your action plan. Will it be the precious kite, or the pencil box, or both as well the chocolates and the sweets? Plan ahead.