Multi-cap rejig could create bubble in small- and mid-caps: Amfi

On September 11, the capital markets regulator issued a circular directing multi-cap schemes to deploy at least 25% each in large-, mid-, and small-caps

Industry body Association of Mutual Funds in India (Amfi) has said that aligning multi-cap schemes to comply with the new definition could lead to the creation of a bubble in small- and mid-caps.  

“The compulsion to deploy about Rs 26,000 crore in small-cap stocks and close to Rs 10,500 crore in mid-cap stocks — in a span of a few months — will most likely create a bubble in those two segments. Majority of small-caps and a large number of mid-caps are highly illiquid,” Amfi stated in a letter to the Securities and Exchange Board of India (Sebi), on September 15.

On September 11, the capital markets regulator issued a circular directing multi-cap schemes to deploy at least 25 per cent each in large-, mid-, and small-caps. At present, such schemes manage Rs 1.47 trillion in assets.

Close to 75 per cent of these assets is invested in large-caps, i.e. the top 100 firms by market capitalisation. About 17 per cent is invested in mid-caps (firms ranking 101-250) and only 6 per cent in small-caps (entities outside the top 250).

In the letter, Amfi has underscored the challenges of investing in smaller stocks.

 

 

“It is pertinent to mention that several small-cap funds have periodically put restrictions on incremental or even SIP (systematic investment plans) flows, on account of the extreme illiquid nature of the market. While large-cap index funds have been growing, the industry has not been able to offer ETFs in mid- and small-cap indices, owing to the poor liquidity,” it has written.

Amfi added that the circular compels MFs to buy stocks in the broader universe at expensive valuations. 

“The knowledge of compulsive buying by multi-cap funds could encourage market participants to hold on to illiquid stocks till the MFs come close to their target. These stocks could then crash once the artificial rush of MF purchase is over, because fundamentals will not support the prices. This, in turn, could adversely impact unit holders of the fund, as their money will be deployed at high prices,” the letter stated.

Amfi pointed out that while the intent of the circular was “laudable”, the proposed changes could have “unintended consequences”. 

“We believe the standardisation of MF scheme categories to ensure truth in product labelling and avoid misleading names is a landmark reform introduced by Sebi.” 

In the letter, Amfi gave a few recommendations. The first was to rename the existing multi-cap fund category to “flexi-cap”, to allow dynamic allocation to all three stock categories.

Second, it urged Sebi to introduce a new category with the same characteristics mentioned in the September 11 circular. Third, it asked Sebi to consider prescribing weights in line with the m-cap distribution. Mid-caps currently account for about 16 per cent and small-caps about 11 per cent of India’s total m-cap.

The Sebi circular comes into effect from February 2021. However, Amfi has sought more time from the regulator for compliance.

On September 13, Sebi clarified that rebalancing was one of the many options available. The regulator has, however, stayed put on the new definition despite widespread criticism.