SEBI's Multicap Fund Norms: Small and Midcaps ready to fly

Todays SEBI classification is expected to mark a heavy rally in mid and small-cap stocks

The SEBI circular basically focuses on asset allocation for Multicap funds. As per the new classification guidelines multicap funds ;

Would have to invest at least 75% of the funds in equity instruments
Would have to invest a minimum of 25% in large-cap, midcap, and smallcaps stocks respectively.

To put things in perspective – the total AUM of multi cap funds is currently 1.46 lakh crores.

Average exposure of multicap funds ;

Largecaps ~ 72%
Midcaps ~ 15%
Smallcaps ~ 9%, Rest – Cash

The next three months could mark one of the biggest shuffling exercises in MF portfolios as the new notification comes into effect from February 1, 2021.

Let’s have an objective look at the merits of this decision and what it may entail for a Retail Investor;

It gives much-needed relief to a largely ignored part of the market – especially smallcap companies. Smallcap companies have been heavily battered post-Demonetisation. As more and more business got shifted to more organized players, massive polarization toward large-cap companies has been noticed in the last few years. Today’s SEBI decision effectively reroutes some of the much-needed liquidity to the Smallcap and midcap Space.

Since capital raising will be difficult for many companies in the current scenario, expect a lot of QIPs ( Qualified Institutional Placements) by these companies in the next few months. Not only will that increase much needed institutional presence in smaller companies but will also ensure adequate liquidity in the secondary market.

There will be a likely selloff in the large caps. – Since SEBI has given a clear mandate that small and midcaps should at least constitute 50% of the current holdings of a multi cap mutual fund, a minimum of ~ 25% selloff could be expected in large-caps.

As the total AUM of the multi cap universe is 1.46 lakh crores, a ~25% selloff comes around to be 36,000 crores.

Liquidity is a mirage in small-caps – The market depth in the small caps is very weak and liquidity is a mirage. To get a substantial stake in any smallcap, Most MFs might just have to take the QIP route as getting a large block of shares in the secondary market will not be feasible. It should be noted that recently a very notable PMS and SBI Mutual fund stopped accepting further inflows in their smallcap schemes as the liquidity was very poor.

Mutual funds might just merge schemes – In a way, the SEBI decision forces the AMC to forcefully change the mandate of the entire fund. There could be many causes that the fund manager may not be comfortable with giving a 25% asset allocation to small/midcaps if he cannot stop the opportunities. Instead of needlessly taking risks, it expected that many AMCs might just merge their multicap schemes with their existing large-cap schemes.

What should you as a Investor do?

While it’s enticing to jump the wagon and start buying small-caps from Monday, One should always keep in mind that the Post COVID Investable universe is going to be very different. It’s expected that roughly 1/3rd of the current small/Midcap universe may not be investable in a post COVID world. Invest in well-researched companies that have adequate depth and a high certainty of sustainable growth in the future.

While it’s enticing to jump the wagon and start buying small-caps from Monday, One should always keep in mind that the Post COVID Investable universe is going to be very different. It’s expected that roughly 1/3rd of the current small/Midcap universe may not be investable in a post COVID world. Invest in well-researched companies that have adequate depth and a high certainty of sustainable growth in the future.