Rs 40,700 crore multi-cap funds rejig: What SEBI's clarification means for investors

Sensing big disruption potential of multi-cap investment adjustment guideline, which required multi-cap funds to invest at least 25% each into large-cap, mid-cap and small-cap funds, SEBI has now come up with a clarification that there are a lot of alternatives which AMCs can explore for a smooth transition, and to meet investment limit requirements.

As per Morningstar India, SEBI's previous guideline on investments by multi-cap funds meant that around Rs 40,700 crore would have to be taken out from large cap stocks of multi-cap funds and moved to mid-cap and small-cap stocks, if these funds opted to continue as multi-cap fund. Out of this Rs 13,000 crore would have to be invested into mid cap stocks and Rs 27,700 crore into small cap stocks.

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Total AUM of small cap fund was Rs 52,119 crore on August 31, and if multi-cap invested Rs 27,700 crore which is more than 50% of existing AUM in this specific category, it would have destabilising effect on small cap stocks. Even mid cap stocks would have seen inflated demand while large cap stocks would see correction.

Also read: SEBI clarifies on new multi cap fund rule, says mutual funds have many options

Multi-cap funds were largely following composition of equity market capitalisation in their portfolio distribution with more than 70% investment in large cap stocks, which was often similar to large cap funds. If we follow market capitalisation of BSE 500 companies, 78% of market capitalisation belongs to top 100 companies, 16% to mid cap companies and only 6% to small cap companies. This is largely what multi-cap funds followed.

If all multi-cap funds decide to continue as multi-cap fund it would potentially disrupt the entire equity market as mid cap and small cap stocks hardly have the capacity to absorb intended investments. While top large cap companies have well over Rs 1 lakh crore of market cap, all small cap companies in BSE 500 put together have a minuscule market cap of Rs 9.1 lakh crore. This means that the scope of absorbing big investment is not evenly balanced into these three different categories.

This is what created a strong buzz in the capital market about possible disruption due to demand supply mismatch in mid-cap and small cap stocks due to the decision. Now the regulator has hinted that there are various ways through which AMCs can implement this without disrupting the market.

Also read: BT Buzz: How changes in multi-cap funds will affect your investment after new SEBI rules

"Apart from rebalancing their portfolio in the Multi Cap schemes, they could inter-alia facilitate switch 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, for instance Large cum Mid Cap scheme," said the press release from SEBI.

This would mean that not all multicap funds will continue as multicap funds and investors will be given preference to switch their money into an alternative scheme. "Mutual Fund Industry's endeavour is to optimize risk adjusted returns for the unitholders. Given the flexibility now offered by SEBI to facilitate switch to other schemes or merger of schemes, appropriate portfolio changes will accordingly happen in an orderly fashion" said AMFI.

Also read: SEBI hikes minimum investment corpus in equities to 75% for multicap funds

The regulator has also emphasised that there is ample time given to funds to implement the guideline without bringing disruptions. "SEBI is conscious of market stability and therefore has given time to the Mutual Funds till January 31, 2021 to achieve compliance with the circular, through its preferred route of which rebalancing of the portfolio is only one such route," the SEBI said.

The market regulator has also indicated that it is open to suggestions from the stakeholders. It has sought feedback from the stake holders on facilitation of smooth transition. "AMFI will gather feedback from members and revert for non-disruptive execution of multi cap funds portfolio balancing," said AMFI.