We have all come across the famous advertisement, “Mutual Funds, Sahi Hai” implying that these instruments are a favourable avenue for investments, but what are these mutual funds and why is everybody talking about them off-late. A mutual fund scheme pools money from multiple investors which is invested in shares of listed companies, government bonds, corporate bounds, other securities, or a combination of such investments.
This scheme is quite favourable as it is professionally managed by an asset-management company (AMC), that utilizes the money given by a group of individuals. The dealings take place in such high values that these asset management companies play a role in moving the market, depending on their transactions.
Further, the scheme helps in diversification of investments, which in turn reduces the amount of risk involved. If a mutual fund scheme includes various stocks, securities then even if some of the stocks may not perform, their loss is usually covered by performance of other securities. The returns may not be as high, but the risk is certainly minimized.
Mutual funds are measured according to the price of one unit of the fund, called the Net Asset Value (NAV), which fluctuates according to the fund holdings. Therefore, instead of buying shares, units of the fund are purchased, and each investor participates in the gain or loss of the fund.
Mutual funds are regulated by the Securities Exchange Board of India (SEBI). It plays a crucial role as it formulates policies, regulates the major players in the industry and sees to it that the investors are protected.
SEBI CIRCULAR, 6TH OCTOBER 2017
In October 2017, SEBI issued a circular that discussed the “Categorization and Rationalization of mutual fund schemes” and all major directions with respect to mutual funds were mentioned therein. SEBI’s aim was to create a certain uniformity in the characteristics of similar type of mutual fund schemes, so that different schemes could be easily distinguishable. The idea was to create brackets, so that an investor could make an informed decision without having to get into complexities.
Accordingly, mutual funds were categorized into Equity schemes, Debt schemes, hybrid schemes depending on what the fund would invest predominantly in. For instance, an equity scheme will consist mainly of stocks, whereas a debt scheme will consist primarily of bonds. This was just a broad distinction and each type was further sub-divided into different categories. A multi-cap fund has been mentioned as one of these sub-divisions.
A multi-cap fund is an open-ended equity scheme, wherein equity and equity related instruments are 65% of the total assets, that invests across small-cap, large-cap and mid-cap stocks. This definition is quite complicated as we are not well versed with most of the underlying terms.
Hence, for simpler understanding a large-cap company is one that falls within the top 100 companies with respect to market capitalization(aggregate value of the company). A mid-cap company is one that falls between 100 and 250 while considering their market capitalization and any company beyond the top 250 is considered a small-cap company.
Mutual funds schemes exist with all sorts of instruments in them. Even within the equity scheme, there is a Large-cap fund which consists of at least 80% large-cap company stocks. In such a way there are small-cap and mid-cap funds as well, each with their own percentage stipulation to meet.
Therefore, in simple language A multi-cap fund is an assortment or a mixed bag of stocks of companies that have a varied market capitalization so that some fall under large-cap, some under mid-cap and some under small-cap. Its only condition was that at least 65% of the assets must be stocks, well at least until last week.
SEBI CIRCULAR, 11TH SEPTEMBER 2020
This circular was issued to give further instructions regarding the “Asset allocation of multi-cap funds” as there was ambiguity with respect to its underlying assets. SEBI started the Multi-cap fund, so that there was a balance between risk and returns. It is a known fact that large-cap funds are less risky as compared to a small-cap fund which is quite dicey but may give huge returns. This is how, a multi-cap fund was to get the best of both worlds through a diversified portfolio.
On examining these multi-cap funds for almost three years, SEBI found out that most of the multi-cap funds were large-cap heavy, which meant they comprised mostly of large-cap stocks. This also meant that these schemes had near zero or insignificant allocation of Mid-cap and small-cap company stocks.
According to data from Morningstar, of the 35 multi-cap funds, 32 had over 50 percent allocation to large-cap stocks. Of this, 28 schemes had between 65 percent and 92 percent large-cap allocation as of August 31. SEBI felt this was unfair as the fund was not true to its label and decided to take matters into its own hand by releasing the circular.
SEBI decided to add certain stipulations to the assorted basket of large-cap, mid-cap and small-cap companies. It stated that the minimum amount of equity and equity related instruments was to be not less than 75% of the total assets. More importantly, the circular mandated multi-cap funds to allocate least 25% of their portfolios in large, mid and small-caps each by February 2021.
SEBI PRESS RELEASE, 13TH SEPTEMBER 2020
Fund Manager’s all over the country were in panic mode as soon as they read the circular issued by SEBI. It is evident that they have about 6 months to alter their portfolios so that they abide by the regulation limits imposed by the market watchdog. This update set the estimated shift in liquidity up to 40,000-50,000 crore to mid and small-cap stocks from the large-cap stocks which could see tremendous fluctuations in the stock market as a result.
Another concern for the industry is that majority of indexes are skewed towards large-cap companies, and if there is an imbalance there are no suitable benchmarks to rebalance the market. AMCs quickly pointed out that NSE 500, which is a benchmark for multi-cap schemes, also has just about 6% weightage towards small-cap stocks and 14% to midcap stocks.
In a time as turbulent as today, such a decision was not welcome by most unitholders in the industry, so much so that SEBI had to issue a press release clarifying its stance on multi-cap funds. SEBI tried to ease some of the concerns by stating that rebalancing is just one of the numerous options available to fund managers.
SEBI further clarified by stating the importance of market stability and giving the fund manager’s a variety of options to fall within the regulation limit. Some of the suggestions were to inter-alia facilitate switch to other schemes or to merge their multi-cap scheme with their large-cap scheme. The press release ended with SEBI being open to proposals from the industry if the multi-cap fund stays true to its label and within the correct regulation limit.
SEBI has issued the circular and further clarified their position. Now the ball is in the AMCs court. Most schemes will not resort to re-allocation as maintaining 50% in mid and small-cap irrespective of its valuation will make the scheme unviable for existing investors.
Nilesh Shah, head of Kotak AMC, who runs the largest multi-cap fund stated that it is imperative to abide by the regulations, but it is also vital to do what is right for unitholders. Re-allocation would be unfair to the existing unitholders and all options would be explored so that a successful investment process is carried forward with minimum disturbance. He also promised returning money to clients instead of re-allocation, as it would be unjust to them.
The most practical solution looks like changing the category or merging the multi-cap category with other relevant category schemes. Another possibility is to change category to the focused category wherein there is no market cap category issued by the SEBI. There is also talk about requesting SEBI to introduce a new ‘flexi category’ wherein there is flexibility with respect to large, mid and small-cap stocks.
Since SEBI released the circular, articles such as “Best small-cap stocks to invest in” have been trending all over social media. Further, business news channels have been holding debates discussing the approximate percentage rise of mid-cap stocks.
The truth is that these stocks are still a grey area as it is difficult to predict what route is chosen by the mutual funds. Moreover, with the economy is still in shambles due to the pandemic and the US elections at the end of the year, it maybe better to be wary than sorry.
With respect to existing mutual fund holders, it is best not to get bogged down by such news. Both SEBI and the AMCs are working to promote and protect the interest of the investors and a viable solution will be thought out sooner or later.