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Photo: Mint

Brace for a churn

While it’s true that multi-cap funds are supposed to vary their stock selection, making fund managers adhere to a stiff ratio of stock categories would force them to manage a mix they do not deem optimal on a risk-return test

The Securities and Exchange Board of India’s insistence on Friday that multi-cap mutual funds invest at least a quarter of their corpus each in large-, mid- and small-cap stocks was aimed at ensuring portfolio diversification, but it could now set off a major asset allocation churn. About 40,000 crore would’ve had to flow from large-cap scrips, which account for the bulk of their holdings, to shares of smaller companies. As these see thin trade volumes, inflows could give them more liquidity and eventually make it easier for such firms to raise capital.

Yet, that could also push their prices beyond their inherent value. Already, mid- and small-cap valuations are seen as overstretched. While it’s true that multi-cap funds are supposed to vary their stock selection, making fund managers adhere to a stiff ratio of stock categories would force them to manage a mix they do not deem optimal on a risk-return test. Specifically, with smaller firms doing badly, the rule could load multi-cap funds with greater risk. As that’s unfair to investors, this fund category may even have to thin out. That’s an option fund houses could exercise, the regulator suggested Sunday. Sure. But the churn won’t be pretty.

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