Is AMFI guideline on mutual funds’ froth build-up responsible for small-cap, mid-cap crash?
- After SEBI raised concerns over the froth building up in the small-cap and mid-cap segments, AMFI directed mutual funds to go for stress tests once every 15 days and disclose the outcome from March 15.
Stock market today: The Indian stock market came under heavy selling pressure on Tuesday as the majority of the indices ended in the red in the previous session. While some bottom-fishing is witnessed in the key benchmark indices, the small-cap and mid-cap indices are still under huge selling pressure.
In the last two trading sessions, the small-cap index corrected from 44,653 to 42,751, logging around 1,900 points drop or 4.25 per cent decline. The mid-cap index nosedived from 39,852 to 39,312 levels, recording a 1.35 per cent dip in two days.
According to stock market experts, selling pressure in the mid-cap and small-cap indices is mainly due to market regulator Securities and Exchange Board of India (SEBI) raising concerns over the froth building up in small-cap and mid-cap segment, which prompted the Association of Mutual Funds in India (AMFI) to direct mutual funds to go for stress tests once every 15 days and disclose outcome from March 15. The move is aimed at assessing the time taken to exit the position in a weak market.
Experts have pointed out that the move is one of the reasons that has triggered churning in the small-cap and mid-cap portfolio of mutual funds, as money is being shifted to the large-cap quality stocks. However, they maintained that medium to long-term investors need not bother about these developments.
Froth building up in small-caps, mid-caps
On why small-cap and mid-cap indices are falling, Sandeep Pandey, Founder at Basav Capital said, "Current volatility in the Indian stock market, especially in small-cap and mid-cap segment, can be attributed to the market regulator SEBI's concern raised over the froth building up in the small-cap and the mid-cap segment. This prompted the mutual funds body AMFI to ask AMCs (asset management companies) to go for stress tests and asses the time taken to exit the position when the market mood is bearish. The AMFI's directive is one of the reasons for churning in the Mutual Funds PMS. Now, fund houses that don't even take cash calls but had high exposure in mid-caps and small-caps, have churned their portfolio and have moved to large-caps with quality names."
Elaborating upon the SEBI's move, Avinash Gorakshkar, Head of Research at Profitmart Securities said, "If you look at the key benchmark indices, they are either green or witnessing a bounce-back after every fall. This indicates that money is shifting from small and mid-caps to large-caps. So, this is a good opportunity for the medium to long-term investors to rejig one's portfolio by adding quality mid-cap and small-cap stocks."
However, he observed that profit-booking in small and mid-cap was widely awaited as both indices have been in a continuous bull trend in FY24. Indices may recover if the US CPI data coming on Tuesday doesn't disappoint the markets, he noted.
Can stress testing allay SEBI's concern?
On what to expect from this stress testing, Dhirendra Kumar, CEO at Value Research said, "I don't expect any substantial outcome from the much-hyped stress testing as trade volume goes up in a bull market and dries down in a bear market. If you remember the market stress in 2020 after the outbreak of COVID-19, even a quality small-cap or mid-cap stock would have failed the stress testing. So, judging the quality of a stock from a single test won't be enough."
Kumar went on to add that AMC fund managers have to invest in small-cap stocks if investors are pumping money into small-cap schemes. Similarly, they have to invest in mid-cap stocks. He advised investors to have a time horizon because long-term investors generally get a better return on their money.
On February 27, 2024, SEBI asked the country's asset managers to give investors more information about the risks associated with their small and mid-cap funds.
What existing SEBI mechanism says
As per the rule, AMCs need to invest at least 65 per cent of their assets in small-cap stocks to be categorised as a small-cap fund and the remaining 35 per cent can either be in cash or invested in large-cap stocks. The rule is the same for mid-cap funds.
It should be noted that small-cap stocks are those that have a market cap of up to ₹5,000 crore while mid-cap stocks are those which have a market cap of ₹5,000 crore to ₹20,000 crore.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.
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