Mutual funds huddle to play Sebi's googly on multi-cap schemes

Markets regulator to examine proposals by industry on ensuring compliance with true-to-label and appropriate benchmarking

The Rs 27-trillion domestic mutual fund (MF) industry will soon get into a huddle to decide how to play the Securities and Exchange Board of India’s (Sebi’s) googly on multi-cap schemes.

Sources say the scheme merger, label change or requesting Sebi to introduce a new category are among the options mulled by asset managers.

Industry players will soon build a consensus and approach the markets regulator.

Sebi has also taken a flexible stance. In a statement on Sunday, the regulator said rebalancing is just one of the routes to achieve compliance with the circular and fund houses can opt for other methods as well.

“Sebi would like to clarify that MFs have many options to meet the requirements of the circular, based on the preference of their unitholders. 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,” it said.

To ensure, these schemes are ‘true to label’, the stock market watchdog on Friday directed fund managers of multi-cap schemes to invest a minimum 25 per cent of their corpus in large-, mid-, and small-caps. In the absence of any such threshold, almost all the 35 open-ended schemes in the category run a large-cap bias. Several schemes have insignificant or zero exposure to small-caps.

Sebi’s circular on Friday sparked fears that MFs would have to undergo a Rs 65,000-crore worth of churn.

The realignment would involve dumping large-cap stocks and aggressively buying small- and mid-caps whose gauges have rocketed 60 per cent and 50 per cent, respectively, from this year’s lows. Many raised concerns on whether the small-cap universe would be able to absorb this kind of demand without price distortion.

Many brokerages also issued notes, advising clients to lap up stocks in the broader market universe to benefit from the MF buying. However, given the many options available with fund houses, the projections of huge flows into small-caps may not materialise.

Some fund houses believe merging multi-cap fund with a large- and mid-cap fund could be a good option. According to the Morningstar data, the average large-cap holding for the 35 multi-cap schemes is 75 per cent; while mid-cap and small-cap deployment is 17 per cent and 6 per cent, respectively. Only two multi-caps schemes at present have 25 per cent invested in small-caps and only four schemes have 25 per cent holdings in mid-caps.

Another option before fund houses is to request Sebi to create a new category called flexi-cap, which gives fund managers the discretion to have exposure to the three universes. This would entail just changing the category and would help prevent any churn.

The 35 multi-cap schemes had a combined market capitalisation (market cap) of Rs 1.46 trillion at the end of August, making it the biggest equity segment category after large-caps.

The industry could also request Sebi to rethink the definition of multi-caps to one more aligned with the market structure. The 100 stocks in the large-cap category have a combined market cap of Rs 99.3 trillion — 74 per cent of the total market cap.

The 150 stocks in the mid-cap category have a market cap of Rs 21 trillion — 16 per cent of the total market cap and the remaining 4,500 listed stocks that fall in the small-cap category have a combined market cap of just Rs 14.3 trillion — 11 per cent of the total market cap. These figures are based on the market cap list published by industry body Association of Mutual Funds in India for the first half of 2020.

Industry players believe instead of the 25:25:25 formula, Sebi should set the minimum threshold, according to the complexion of the market. If one extrapolates multi-cap holdings with India’s market-cap distribution, it shows that such schemes’ exposure to large- and mid-caps is largely in line with the market, but they are 500-basis points underweight small-caps.