SEBI attempt to aid smallcap, midcap stock buying may backfire; could fuel small stocks selloff

With SEBI making an unprecedented move last Friday as it asked multi cap schemes to be “true to label” and allocate a minimum of 25% to large cap, midcap, and small cap stocks, a number of market participants have begun compiling a list of stocks that could benefit. Largely, these include midcap and smallcap stocks. However, with most of multi cap schemes that are currently playing in the market having massive equity exposure to large cap stocks, the possibility of them reclassifying as large cap schemes can not be ruled out. Such a reclassification would not force them to buy what they have evidently been avoiding so far.

What could mutual funds do now?

“From the initial reaction of the Mutual Fund industry leaders, they are not gung ho about re-shuffling their portfolio in a hurry just for the sake of complying with the needs of SEBI circular,” Divam Sharma, Co-founder at Green Portfolio, a SEBI Registered Portfolio Management Service told Financial Express Online. Currently, some of the biggest asset management companies running multi cap schemes have opted to invest heavily in large cap funds, which they were allowed to do. HDFC Equity Fund has 86% allocation towards large cap stocks, Motilal Oswal multi cap 35 fund has 89% assets allocated to large caps, and Kotak Standard Multicap Fund has 78% exposure to large caps. Most of these funds have allocated less than 10% to small cap stocks and less than 20% to midcap stocks.

If these multi cap schemes were to abide by SEBI guidelines, funds like Kotak Standard Multicap Fund would need to buy over Rs 7,000 crore of small cap stocks and over Rs 2,000 crore of midcap stocks, according to estimates pegged by Edelweiss Research. For HDFC Equity Fund, over Rs 7,200 crore worth of small and midcap buying could be in the offing. “25% exposure in small caps will be very difficult for bigger funds to manage. Most probably they will either merge it with large cap funds or large + midcap funds that they already have,” said Omkeshwar Singh, head-RankMF, Samco Group. Singh further added that for funds that do not have large cap schemes currently, might reclassify their multi cap schemes.

Could result in heavy selling

Large cap funds need to have 80% of their allocation towards equity and equity related instruments of large cap companies. While many multi cap funds do have high large cap exposure there are some that have less than 80% allocation towards large cap. To reclassify, such funds could trim their holding in small cap companies. If a number of multi cap funds resort to reclassifying and mergers, selling small caps could result in massive price drop in such stocks. Experts say that small cap stocks usually are more volatile that other stocks and even slight selling could move prices. Amar Ambani, Senior President, Yes Securities earlier this week said that 55% of value of Multi cap funds can possibly reclassify themselves as Large cap funds.

Market watchers have called the new guidelines to be unprecedented. An industry participant said that the move goes against the nature of the market itself. Multi cap funds have largely kept the Nifty 500 as their benchmark. The whole purpose of keeping the Nifty 500 as benchmark is to beat the gains registered by the benchmark index. By its constitution, the Nifty 500 index has over 75% large cap stocks.

Large fund mobilization may also hurt

Experts say that currently, calculations show that multi-cap funds have a total AUM of Rs 1,46,500 crore with almost 74% of AUM being allocated to large caps stocks while allocation to mid and small caps are 16.5% and 6.2% respectively. “If the SEBI recommendations are implemented then there could be a shift of ~ Rs 41,000 crore from large caps to mid and small caps on the higher side. As per our calculations small caps would be attracting the lion’s share of the allocation shift at ~ Rs 28,000 crore followed by mid caps at ~ Rs 13,000 crore,” said Jyoti Roy – DVP- Equity Strategist, Angel Broking. However, such large fund mobilization into small cap stock could prove to be an issue with valuations already on the higher end.