Mutual funds' narrow midcap universe: Only 150 firms to invest in

Assets already accounted for nearly a fifth of free float

Mutual fund (MF) allocations to the midcap segment may be under a question mark in light of the fact that it has only 150 companies to invest in, and a good part of the publicly available shares are already in the hands of domestic funds.

MFs’ midcap holdings account for 18 per cent of the free float of the companies concerned, shows a Business Standard analysis of data from fund tracker Value Research and market data from corporate tracker Capitaline.

While this does not necessarily ring alarm bells on an immediate basis, the universe bears watching and may require changes to regulatory definitions as markets grow, say experts.

This gains significance in light of the fact that the figure was in single digits for both large-cap and small-cap funds, which leaves such funds far more room on investments.

One expert said that the narrowness of the universe leads to ballooning valuations because all the money is chasing a limited number of companies. This in turn also contributes to such schemes outperforming as long as the liquidity keeps flowing.

“Once the liquidity reduces, which is already happening, outperformance will also shrink,” said the person, who declined to be identified.

Dhirendra Kumar, chief executive officer of fund tracker Value Research said that one may need to look at revaluating the classification of midcap stocks in the future so that it is not a rigid number which limits choice for the fund manager.

A fund manager, who handles midcap schemes, too agreed that the universe narrowly defined. He declined to be identified because of company policy. He added that the leeway to invest up to 35 per cent outside the midcap universe provides some degree of flexibility for now.

Stock market regulator, the Securities and Exchange Board of India (Sebi), allows even midcap schemes to invest over a third of their assets in the securities of non-midcap companies, according to the regulator’s October 2017 circular. The circular also said that a list of companies that fall into the large-cap, midcap and smallcap universe should be prepared on a periodic basis. The top 100 stocks in terms of value are considered large-cap, the next 150 are midcap and the remainders are all smallcap.

The largecap universe thus has the most liquid stocks with the highest amount of shares by value accessible to the public.  The smallcap segment has thousands of listed companies, though small, to choose from. Midcaps are sandwiched between the two, with a narrow list of 150 companies with neither the liquidity of the large-caps nor the number of stocks available to the smallcap universe.

While the list of stocks that are classified this way are only available in recent times, Business Standard prepared a back-dated list based on quarter-ending market capitalization, which gives an idea of broad trends since 2013. Not all companies have disclosed shareholding data for the September quarter this year.  So free-float was calculated based on June numbers, with corresponding figures used for MF assets.

The midcap space has had the least headroom, and it has only shrunk in the days leading up to June 2018.  Mutual fund holdings to smallcap and largecap stocks are still in single digits, though it has moved up since 2013.

Pankaj Tibrewal, senior vice president and equity fund manager, Kotak Asset Management said that the midcap universe may be sufficient based on current assets but bears watching in the future.

“It is not a big handicap from a portfolio perspective but one can look at these definitions as part of an ongoing exercise as the market evolves,” he said.

— Midcap universe limited to 150 stocks

— MFs chasing same companies, bid up valuations
— Other categories such as multicap funds also invest in midcap stocks
— Total MF allocations accounted for 18% of midcap free float
— Segment lacks liquidity of largecaps
— Not as many stocks to invest in as smallcap universe
— Definition may need changes in future, say experts