‘Sebi move is positive for stock markets, mutual fund investors’

Mutual funds must comply with the Sebi directive on portfolio composition of multi cap funds by January 2021. The change could lead to an estimated outflow of Rs 40,600 crore from large cap stocks to mid-caps (Rs 12,900 crore) and small caps (Rs 2...

By Amit Kumar Gupta

Mutual funds must comply with the Sebi directive on portfolio composition of multi cap funds by January 2021. The change could lead to an estimated outflow of Rs 40,600 crore from large cap stocks to mid-caps (Rs 12,900 crore) and small caps (Rs 27,700 crore). Some funds might get merged while others could switch categories. Even so, at least Rs 10,000 crore will flow into the small and midcap segments.

The government’s divestment targets have faced issues due to the Corona pandemic. If the buying comes in some of the mid and small cap PSU companies, it can help in higher revenue generation which can be utilized in fighting the pandemic better and to help weaker sections of the society. Sure, that requires ticks on business models, moats, cash flows etc but we have seen in the recent divestments of HAL and BDL, how stock price excitement post defence policy was smartly used to offload shares in the OFS.
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Most multi cap portfolios have large exposure in large cap stocks. This new move will lead to better diversification across industry sectors, particularly fast growth new-age tech sectors where large cap stocks do not have enough presence. It is also clear that by this move, regulators are making a statement of over ownership in certain large cap stocks and like to see a broader move in the markets rather than polarization.

The changes in minimum allocation to mid-cap and small-cap companies could encourage various unlisted small businesses to get better price discovery via IPO listing. Mutual funds with larger choices in this space will allocate higher proportion to good companies. This is also an indirect way in helping the government in providing stimulus for small and micro cap companies to allow them to raise money in the post-Corona world.

The selling of large cap stocks by multi cap funds will be easily absorbed as most of them are highly liquid names. Moreover, as in the case of merger, this will be an inter-scheme transfer within a fund and it will not come in the market. Hence, the fear of large caps falling sharply is unwarranted. On the other hand, buying in mid and small caps will enhance shareholder value, if done correctly.

Sebi has been proactive to clearly tell fund houses that their reason for making this change is to be true to the labels and not to curb the independence of how to manage the funds. They have been given sufficient time and various options to carry forward the change. With a balanced allocation, the funds can reduce their risks and performance across market cycles as large caps tend to outperform during bear markets and early stages of bull markets.

Having said that, there are some caveats. Mid and small cap stocks are quite thinly traded, and inflows of Rs 13,100 crore and Rs 28,000 crore into them may require several weeks of trading to achieve the required re-balancing (unless there are new issuances).

Another likely issue is that even before the MFs get around to buying these stocks, there could be a lot of non-institutional/retail actions in some of the stocks in the hope of their prices rallying in due course of time due to the institutional buying actions. This was evident on Monday's move of 3% in midcaps and 5% in small cap index.

Lastly, we all have seen in the recent past, the high MFs holding in a small cap stock is a two-edged sword. In the good times, the stocks run up sharply; and when the tide recedes the losses are also overwhelming (remember 8K Miles, HEG, Graphite, Eveready etc). Even the best of the fund managers have lost huge money in stocks like JP Associates, HCC, Jet Airways etc. For investment in mid and small cap space, the foremost criterion should be to look for respective sector leaders, niche players with strong balance sheets and companies which can manage during bad market cycles.

(Amit Kumar Gupta is Portfolio Manager – PMS at Adroit Financial.)

(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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