'Mind your smallcap exposure, if multicap funds comply with Sebi's portfolio rule'2 min read . Updated: 18 Sep 2020, 07:04 AM IST
Even the BSE 500 Index which is the broad Index and is generally a benchmark for most multicap fund has only a 6.5% allocation towards small cap funds.
By Raghvendra Nath
SEBI recently came out with new guidelines for redefining the Multicap funds and it has now prescribed a minimum investment of 25% each in small, mid and large cap category. Till now the guidelines had provided flexibility to the fund manager to decide the allocation to the three market cap categories. Most Multicap mutual funds have an overweight on large cap stocks, followed by mid- cap and generally have a very small allocation towards small cap stocks.
The reason for such allocation is very simple, while the small cap may demonstrate higher growth rate in the future, most of these stocks suffer from higher illiquidity. The capital base of these small cap stocks is very small and the promoter holdings are major part of the shareholding pattern, leaving very little floating stock in the market. Due to this illiquidity the impact cost of investing or exiting into small caps is very high.
For instance, if a small cap stock has a daily volume of 5,000 shares, and the fund manager wants to buy 1lakh shares he may only be able to do so with an impact cost of 20-30%.
The reverse is even more damaging, for instance one of the more popular small cap stock, Manpansand beverages had corporate governance issues which had led to sharp fall in the stock prices. In such a situation the fund manager can get stuck with the holding that they have and helplessly watch the stock prices become negligible.
Therefore by forcing fund managers to keep a minimum 25% exposure in a small cap category will completely change the risk profile of the fund.
The Funds industry in general is making representations to SEBI to reconsider the guidelines, if that is not possible many funds may change the nature of the existing multicap funds in order to avoid increasing the exposures to small cap category.
From an investor’s standpoint, multicap has been one of the preferred categories as it gives investors an opportunity to participate across market caps through a single fund.
The fund managers also took advantage of market opportunities at a stock level without worrying too much about the requirements of small cap exposures.
Investors should not act in hurry
Basically as an investor you should not act in a hurry right now as most fund houses are evaluating the best course of action in order to maintain the risk profile of the respective funds. Investors should basically get in touch with their advisors and specifically ask for the fund houses view of the multicaps that they hold.
In case the fund house confirms that it is going to comply with the SEBI guidelines investors should see their overall allocation of small caps in their equity corpus. If at an underlying level the small cap exposure is 10-15% then the investor can continue to stay invested in the multicap fund. But if the investor holds a lot of small cap funds because of which the exposure is getting skewed, reducing the small cap exposure would be a good idea.
Surprisingly even the BSE 500 Index which is the broad Index and is generally a benchmark for most multicap fund has only a 6.5% allocation towards small cap funds.
The whole rational for investing in multicap funds was providing flexibility, which will now be lost if this regulation stays as is. Hopefully SEBI will create an alternate flexi cap category to fill this void.
(The author is MD, Ladderup Wealth Management. Views expressed by the author are his own.)