Top reasons AMC's stopped accepting fresh lump-sum investments in small-cap funds
Fund houses and managers have a responsibility to protect the interests of their existing investors.
Introduction
Investing in mutual funds, particularly Small-Cap funds, has become a popular topic of discussion among investors. However, recently, some asset management companies (AMCs) have announced that they will no longer accept lump-sum investments in certain schemes, raising questions about the reasons behind this decision. In this article, I’ll shed light on the prominent factors influencing these AMC's choices.
Challenges of Small-Cap Funds
Small-cap funds are known for their potential to provide high returns due to the volatility and growth potential of smaller companies. Their rapid ascents and descents often attract investors' attention. However, when the assets under management (AUM) of a small-cap fund increase significantly, several challenges arise.
1. Difficulty in Deploying Funds: As the AUM of a small-cap fund grows, the fund manager may find it increasingly challenging to effectively deploy the accumulated funds. This difficulty arises due to limited investment opportunities within the small-cap segment. When this situation occurs, the AMC may choose to restrict larger lump-sum investments while continuing to allow systematic investment plans (SIPs) and systematic transfer plans (STPs).
2. Valuation Concerns: During periods of sharp market upswings, particularly in the mid and small-cap segments, valuations for these companies can become excessively high. This can create discomfort for fund managers, as investing at such elevated valuations may not align with their investment strategies. To avoid compromising investment decisions, AMCs may restrict new inflows through lump-sum investments.
3. Protecting Existing Investors: Fund houses and managers have a responsibility to protect the interests of their existing investors. When significant inflows are accepted but cannot be effectively deployed, the performance of the fund may be negatively affected. This could lead to underperformance or a sharp decline in the net asset value (NAV) of the scheme, causing existing investors to suffer. To mitigate these risks, AMCs often implement measures to restrict such flows.
Challenges Faced by Fund Managers
The decision to restrict fresh lump-sum investments in small-cap funds arises from the challenges faced by fund managers due to the rapid growth in asset size and the potential impact on liquidity.
1. Increasing Asset Size: Small-cap funds have witnessed substantial growth in asset size over the years. For example, from May 2020 to May 2023, the AUM of small-cap funds in India surged from Rs 38,820 crore to Rs 1.54 lakh crore. This rapid growth means that larger funds are compelled to invest in the same assets that have already experienced significant price appreciation, making it challenging to identify attractive investment opportunities.
2. Liquidity Concerns: As the AUM of small-cap funds expands, liquidity management becomes crucial. The limited headroom from current levels poses a challenge for fund managers who need to ensure that the funds are invested prudently and that redemption requests can be met without adverse consequences. Restricting lump-sum investments helps in maintaining liquidity and managing potential liquidity issues.
Conclusion
The decision by certain AMCs to halt fresh lump-sum investments in small-cap funds stems from a combination of factors. The challenges of deploying growing AUM, concerns about high valuations during market upswings, and the need to safeguard the interests of existing investors all contribute to this decision. Fund managers face the uphill task of managing large asset sizes, finding suitable investment opportunities, and maintaining liquidity. By implementing measures to restrict lump-sum inflows, AMCs aim to ensure the fund's overall performance and protect the interests of all investors involved.
It is important for investors to understand these factors and consider alternative investment options or investment methods, such as SIPs, to navigate these restrictions and make informed investment decisions.