The small issue of making a multi-cap true to label
4 min read 14 Sep 2020, 09:44 AM ISTEach time in the last 15 years, Sebi has taken investor-friendly steps–doing away with the front loads, upfronting of commission, scheme categorization and so on, there has been a huge push back from the industry.
PremiumAs an investor in a multi-cap fund, you could be feeling really confused about the uproar caused by the 11 September 2020 Sebi circular on making these funds more ‘true-to-label’. What happened is this: the circular changed the earlier rule of allowing a multi-cap fund to invest across market caps as they liked and has put in minimum limits across market caps. A multi-cap fund, from February 2021, must have a minimum of 25% in large-caps (defined as the first 100 stocks by market cap), 25% in mid-caps (101st to 250th stock by market cap) and 25% in small-caps (251st stock onwards). The rest of the 25% can be invested in any of the above three categories, technically allowing a 50% large-cap exposure in a multi-cap fund. You can read the circular here.
The upset is because multi-cap funds will now be forced to invest into the small-cap market, reducing the elbow room available with the funds to manage as they liked. There are three things that you as an investor need to consider before you get caught up in the hysterical outpouring seen last week about this circular. One, financial products are invisible. It is in their description they are created in the minds of investors. Therefore, product labels are very important in an industry that manufactures and sells products that are invisible and whose moment of truth is not immediate, but far in the future. The moment of truth of another invisible service like a mobile data plan is at once. A physical product like a plate of sushi is also immediate. But an equity-linked investment will by its very nature have its moment of truth in the future. Put these two things together and you need mutual fund labels to describe correctly what the investor is buying. Calling a credit risk fund, a credit opportunity fund is a sleight of hand to make risk sound like an opportunity. It has taken a lot of internal push to get the industry to agree to call a ‘risk’ a ‘risk’ and not an ‘opportunity’.
Two, many top multi-cap funds were being run as large-cap funds over the past few years. Some multi-cap schemes have zero exposure to small caps and some have a marginal exposure of under 5%. What’s wrong with that? As an investor in a multi-cap fund, I need a more balanced allocation across the market caps in my portfolio, else I should invest in a large-cap or a large and mid-cap fund. Typically, a multi-cap fund would be bought by a person who does not want the bother of splitting her money between large-, mid- and small-cap and just buying a multi-cap. In 2017, Sebi had made rules around definitions of large-, mid- and small-caps and had given asset class and allocation thresholds for different categories. You can read the circular here.
The logic was to give the investor a true-to-label fund so that she would not find, for example, higher risk mid-cap stocks in what she thought was a safer balanced fund. This was what some marquee schemes from reputed fund houses were doing to show higher returns than funds that were more honest to the name of the category.
Three, look at the assets under management of small-cap funds. The top 10 have a book of between ₹5,000 and ₹10,000 crore. Due to the lack of liquidity in small-caps, fund houses like SBI prudently restrict flows into its small-cap funds and allow only SIPs to manage investor money better. The market knows the problem with small-cap stocks having issues of liquidity and depth and specific small-cap schemes take that into account and then restrict flows. Multi-cap funds will need to do the same if they are to be true-to-label.
The Securities and Exchange Board of India (Sebi) can actually do an Irdai and just let funds do what they like and have generic categories called equity, debt and balanced and then sit back, wash its hands off the mess in the market. Investors typically choose funds on the basis of returns, and when a balanced fund between equity and debt plays the high-risk mid-cap market with a minimal allocation to safer debt, who will the investor blame finally if there is a blow-out?
If we don’t like regulatory intervention in market classification, then why the uproar about finding long-dated bonds in short-term portfolios of some debt funds? Why the upset over finding lower credit funds in what were termed as ‘low’ risk debt funds? So, either we want regulatory action, or we don’t. We literally need to choose between the regulatory styles of an industry association like the Insurance Regulatory and Development Authority of India (Irdai) or an investor-first Sebi.
Each time in the last 15 years, Sebi has taken investor-friendly steps–doing away with the front loads, upfronting of commission, scheme categorization and so on, there has been a huge push back from the industry. I would interpret the current frenzy as more of the same.
Disclosure: The author is on Sebi’s Mutual Fund Committee and has been a part of many internal debates on the issue.
Monika Halan is Consulting Editor at Mint and writes on household finance, policy and regulation.
