Change is the only constant in life, Ones ability to adapt to those changes will determine your success.” – Benjamin Franklin

Recent circular by SEBI [Link] issued on Sep 11, 2020 about the suggested change in the asset allocation of Multi-Cap funds has created a range of questions in the investors mind. The news article suggesting that the INR 40,000 cr is expected to move from Large cap segment to Small & Mid cap category [Link]. Such articles have created two branches of thoughts, first stimulating the worry that the multi-cap funds will become more volatile with increased exposure in Mid & Small cap stocks & Second triggering the greed that extra money inflow in Mid & Small cap stocks will reflect as improved returns in those stocks. I have lost the count of WhatsApp forwards received in last 2 days on this topic here is my assessment.

What has changed?

As per 2017 rationalization of Mutual fund schemes, Multi cap funds were classified to have a minimum investment in equity & equity related instruments of 65% of total assets. An open ended equity scheme investing across large cap, mid cap, small cap stocks. So in theory, the multi-cap fund manager has the largest buffet of stocks to pick and select from vs just any other market cap specific mutual fund category e.g. Large, mid or small cap. The new circular has created further changes in definition to mandate that each category of stocks Large, Mid & Small should have minimum 25% of allocation and overall 75% allocation should be in equity/ equity related instruments.

This change has taken away the ability of Mutual fund manager to pick & chose the stocks they like and allocate the money as per their choice. Most Multi-cap funds moved the allocation between Large, Mid & Small caps based on their understanding of business cycles for e.g. Currently most of the Multi-caps have allocated 65-80% of their portfolio to Large cap stocks.

What is the impact of this change?

In my opinion, market regulators want to increase the depth of the Indian stock market. I have mentioned it earlier, That 75% of market free float is in Nifty 100 companies while 12-15% in Nifty Mid cap 150 companies and single digit for small cap companies. Multi-cap mutual funds have the second highest AUM after large cap funds of INR 1,46,000 Cr [~USD 20 Bn] moving 25% of this AUM towards Mid & Small caps would definitely increase the prices of stock, liquidity and may be volatility.

Just to put things in perspective Total Market cap of Nifty Small Cap 250 stocks is INR 975,000Cr. Since most of these firms are promoter controlled and if conservatively we assume that 50% of this market cap is not available for churn then we are sending 27,000 cr money to add in the current market cap of 487,000Cr. This itself will translate in a gain of 5.5%.

Will the change happen in Multi-cap funds?

The circular by SEBI is a new guideline and would trigger a second level thought among fund managers & AMCs. If they believe that the current changes will be detrimental to the investors of their funds, the alternate options will be explored.

  1. Popular Multi cap funds like Parag Parikh Long Term Equity or Motilal Oswal Multicap 35 own less than 30 stocks and can be classified as focused funds. hence no change in asset allocation required.
  2. Funds which have 65-25-10 kind of allocation will find it easier to merged or classified as Large & Midcap fund rather than selling large caps & buying Mid/Small cap in large quantities.
  3. They can re-appeal to SEBI and request to modify the mandate from 25% each to more amicable split like 30-25-20

What should the investors do?

The speculation of large money moving to small caps or Mid caps can benefit the investors of this segment in short run but once the sense prevails the net gains will be negligible. Though some stock specific rallies might occur still for an average investor of mutual funds, no impact. Also regarding the volatility, In short run Multi-cap funds might witness the higher volatility though over a long term the impact will be minimal because once the required allocation in each category is achieved the churn in portfolios will reduce. Therefore, you do not worry a lot about this change & stay on course of your long term investment plan. Multi cap funds continue to be the category of choice to build your core portfolio.

To know our picks in the Multi-cap fund category read Category Review: Multi cap funds.