Modification in Multi-Cap MFs Asset Allocation rules: How will it impact investors?

On Friday, Securities & Exchange Board of India (SEBI) altered the asset allocation rules for multi-cap funds vide its circular SEBI/HO/IMD/DF3/CIR/P/2020/172 dated September 11, 2020.

With this, SEBI has mandated multi-cap funds to have a minimum of 25 per cent each in large-cap, mid-cap, and small-cap stocks. According to SEBI, this has been done to diversify the underlying investments across large-cap, mid-cap, and small-cap companies to ensure it sticks to its true label. Previously, multi-cap funds were free to move across market-cap. In the following paragraphs, we would explain how the investors would be impacted by this.

As per the new mandate, all the multi-cap funds will need to shift their investments by February 2021. Since mutual funds have only five to six months of time to comply with this mandate, there would be less disruption. However, this change would indeed make multi-cap funds more volatile. This is because almost 50 per cent of its portfolio would be dedicated towards mid-caps and small-caps.

However, this change would not affect funds having asset allocation and also, those with smaller assets under management (AUM). The big task would be for those that are managing big AUMs, as they would need to face some liquidity issues. Further, funds with larger AUMs are skewed towards large-caps for liquidity purposes. It is quite difficult for a large AUM fund to exit small-cap stocks due to lower liquidity. Barring a few, most of the multi-cap funds are essentially the large-cap funds.

With the new mandate, fund managers would have very little room to take calls to switch across market-cap. Besides, this might lead to higher risk and lower reward situation.

SEBI could have capped the minimum exposure of 10 per cent, rather than 25 per cent thereby, enabling fund managers to have their own discretion to change the cap weights. Though this move from SEBI would prove to be good for the new investors, as they would know the investment mandate from day one, yet the existing investors would get impacted. Further, as it would get difficult for large AUM funds to comply with this new mandate, they might think of changing their fundamental attributes to a large or mid-cap fund.

What should investors do?

As of now, investors should keep a ‘wait and watch’ stance. Let the fund houses take their decision of whether to comply with the new norms or change the fundamental attributes altogether.

Further, if the fund chooses to change its fundamental attribute to a large or a mid-cap fund then, monitor your funds for at least three to four quarters. However, if they decide to comply with the new norms then, you should assess what is your risk profile. If your risk profile permits you to hold this fund then, stay invested!