On Sept 11, 2020, the Securities and Exchange Board of India(SEBI) released a crucial circular regarding the asset allocation in Multi-Cap mutual funds. Summary of the circular is as follows:

  • All Multi-Cap funds will allocate at least 75% of the funds to Equity as compared to the earlier 65%.
  • Out of the amount set for Equities, a minimum of 25% each shall be allotted to Large Cap, Mid Cap and Small Cap each, respectively. The was no such limit set earlier on the allocation within equities in Multi-Cap funds.
  • All the existing Multi-Cap Funds shall ensure compliance with the above provisions within one month from the date of publishing the next list of stocks by AMFI, i.e January 2021.

    AMFI or Association of Mutual Funds in India releases a list every 6 months on which stocks are Large Cap, Mid Cap and Small Cap.

Why did SEBI do so?

  • Large-cap funds required a minimum 80% in large-cap stocks, Mid-cap fund required minimum 65% in mid-cap stocks, Small-cap fund required minimum 65% in small-cap stocks. There was no such requirement for Multi Cap funds, except that they needed to invest 65% in Equity stocks.

    A Multi-Cap fund is one that can invest in all segments by market capitalization i.e. Large Cap, Mid Cap and Small Cap. There was no obligation earlier as to where a Multi Cap fund could invest.

    Taking advantage of this, fund manager across India would allocate most of their funds to well-performing large-cap stocks as this would reduce the risk involved and ensure steady returns. They also had the flexibility to invest in well-performing Mid Cap and Small Cap stocks.

    This made the funds, lesser “Multi-Cap” in nature and more of large cap in nature causing a skewed allocation of funds.
Name AUM(Rs. Cr) Large Cap Mid  Cap Small-Cap
Kotak Standard Multicap Fund 29,965.94 72% 28% 0%
HDFC Equity 19,381.37 83% 13% 4%
Motilal Oswal Multicap 35 Fund 11,427.26 87% 9% 5%
UTI Equity 11,144.25 64% 31% 5%
Aditya Birla Sun Life Equity 10,884.43 67% 26% 7%
SBI Magnum MultiCap 8,991.12 73% 20% 7%
Franklin India Equity Fund 8,375.15 76% 17% 7%
Average Investment   75% 21% 4%

The table above shows a list of Top 7 Multi-Cap mutual funds sorted by AUM(Asset Under Management). As seen in the table above it is clear that most mutual funds have allotted more than 50% of their funds in Large Cap stocks. This, if not completely, substantially makes the fund, a Large-Cap fund. This is why SEBI set a floor for the amount invested in each segment.

SEBI’s new regulation where it allots 25% per cent each to Large Cap, Mid Cap and Small Cap shall leave the other 25% at the fund manager’s discretion.

New Structure as Proposed By SEBI for Multi Cap Funds

How Will This Impact The Market?

It is clear now that there will be a divestment in Large cap Stocks. There will be an investment spree in Small Cap and Mid Cap stocks as well, but will this affect market rates much? Let us find out.

  • According to AMFI, the total Asset Under Management for Multi-Cap Funds is Rs 145,907.04 Crores. Out of this Rs 145,907.04 Crores, there will be a divestment of almost Rs 34,000 Crores-Rs 36,000 Crores which is almost 23-25%, in Large Cap stocks.
  • The amount taken out from Large Cap stocks will be invested in Mid-Cap and Small-Cap stocks. However, this shall happen over a period of 3-4 months and should be a gradual process instead of a sudden one.
  • The investment in Mid Cap stocks by Multi-Cap funds will increase by ~4%(nearly Rs.5800 Crores). Moreover, investment in Small Cap stocks by Multi-Cap funds will increase by ~21%(nearly Rs. 29000 Crores).

What does it mean for a retail investor or a mutual fund holder?

SEBI released another circular on 13th September which clarified a lot of speculations. In fact, AMFI welcomed the step and fund managers took on to Twitter to calm investors.

All the points listed above might not happen at all. There is a high probability that mutual fund houses might decide to merge their current Multi-Cap Mutual Funds with other Large Cap Funds or Large Cum Multi-Cap. There is also an option given by SEBI to convert these multi-cap funds to large-cap funds or any of their choice.
Fund houses can also give you an option to move your funds to a fund of your choice.

The amount of outflow in Large Cap funds is about 4-5% of total AUM of Equity Mutual Funds. So impact on market might be significant but not large in magnitude.

To ensure that there is no haphazard in terms of market stability, this transition shall be a gradual process, which will avoid major fluctuations in mutual funds and stock prices. This will also give a time of 3-4 Months to mutual fund houses to figure out and plan the next course of action so there is no need for panic across the board.