Seeking to diversify underlying investments in multi-cap funds, the capital market regulator (SEBI) issued a circular on September 11, 2020, instructing fund houses to modify the characteristics of multi-cap funds such that the funds in this category shall have minimum of 25% allocation to each of large cap, midcap and small cap companies.
AMCs are required to comply with this rule by January 2021.
The Current Situation
Currently, the total AUM of multi-cap funds stands at ₹ 1,46,663 crore. Of this, ₹ 1,08,502 crore is invested in large cap companies which form 74% of the total AUM and only ₹ 24,091 and ₹ 8,742 crore is invested in midcap and small cap companies, respectively.
(Please refer to Annexure: Table 1 for full details at fund level).
The Way Forward
This change in the regulation will force multi-cap fund managers to switch a part of their large cap allocation to midcap and small cap companies. This in turn shall mean:
a) A churn of multi-cap fund portfolios
b) Selling in large cap companies
c) Buying in small/midcap companies
This would result in higher liquidity in the small cap space, which in turn could result in a re-rating of stocks. Also, multi-cap funds which were known to have flexibility to invest across market capitalization will be restricted by this rule.
The extent of re-balancing in multi-cap funds shall require a major shift in the holdings based on the current AUM to adhere to this guideline as most multi-cap funds currently have a large cap bias.
For calculation purposes, we have assumed that the funds get re-balanced to achieve the minimum 25% allocation to each, midcap and small cap. The same shall be utilized by deploying the cash from the portfolio and the balance by reducing large cap allocation in these funds.
We estimate that a Total of ₹ 27.9 thousand crores could move to small cap and ₹ 12.5 thousand crores into midcap companies.Please refer Table 2 below which gives a full break up at fund level.
We believe this presents a great opportunity to invest in small cap funds. As the multi-cap funds re-balance their portfolio, their fund managers might prefer to invest in small cap companies from their universe of stock coverage which could lead to stock duplication with their existing small cap funds. Thereby, for investors who have appetite to take risk, we recommend a portfolio break up of 40:30:30 (%) in large, mid & small cap space, respectively.
Table 1: Current Exposure of Equity MFs as per Market Cap:
Table 2: Potential Re-balance based on Market Cap of underlying
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