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Small caps rise after tweaks by Sebi, but rally may not sustain

Experts say Sebi’s tweaks are not like the reclassification done in Jan 2018, but it’s only about one MF category

A Friday circular by Securities and Exchange Board of India (Sebi) dictating asset allocation framework for multi-cap funds has fired up small stocks. The Nifty Smallcap 100 index soared 5.4% on Monday, and is now just about 6% shy of its pre-covid highs. Valuations, in fact, have soared above pre-covid levels, as many stocks may take a long time to return to the profitability levels seen before covid.

Analysts say that this is a sentiment boost that will lift stocks only in the short run. “It is not a stock classification like the one that happened in January 2018. This time, it’s only about one mutual fund category. The impact will be short-lived. There is a lot of enthusiasm among traders and investors who do small and mid-caps as they would be trying to anticipate moves and get ahead of mutual funds," said Sahil Kapoor, chief market strategist, Edelweiss Broking Ltd.

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Fuelled up

Sebi’s circular mandating multi-cap funds to allocate at least 25% of their portfolios to large- mid- and small-cap each is not expected to see re-allocation in a big way to small-caps. While exposure to small-cap stocks within multi-cap fund category is about 9%, fund houses could use other options available to them, such as restructuring a fund’s mandate or merging it with other large cap funds.

Further, rotating funds to small-cap stocks will have a high impact cost for funds. Most of the small-cap stocks have less liquidity and any buying tends to drive up stock prices in a big way. Analysts also note that it will not be easy for fund houses to fulfil Sebi’s mandate quickly. “At an aggregate level for all BSE-500 stocks that are currently considered ‘small-caps’, it could take 2-3 months of continuous buying for multi-cap schemes to achieve the required re-balancing," analysts at JM Institutional Equities said in a note.

Sebi issued a clarification on Sunday that fund houses can take up re-organization measures such as reclassifying funds as large-caps and merge them with other existing funds. Analysts expect at least 55% of multi-cap funds to use this route in the next few months. “Hopes of a small/mid-cap rally on the back of any rotation are hence likely to be disappointed," said BofA Securities in a note to clients.

Besides, mid- and small-cap valuations are stretching. “The profit pool for mid- and small-cap has shrunk, and profits have not kept up with the large caps. It seems to be more like a sentiment boost for the short term, rather than a material difference over a longer period of time," said Kapoor

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