The new rules for multi-cap funds: How does this impact your funds
The Securities Exchange Board of India (SEBI) released a circular on 11th September. This circular talked about material changes to the portfolio of all Multicap funds. This change was to make sure that Multicap funds invest across large, mid and small cap stocks to stay true to their name. So, what is this change? Before that, let’s understand what are Multicap funds.
Earlier, Multicap funds had to invest a minimum of 65% of their assets under management (AUM) in equities. So, the fund manager was free to decide how much he/she can invest in large cap, mid cap and small cap stocks. As per SEBI, large cap stocks are those that have a market capitalization rank of 1 to 100 on the India stock exchanges. Mid cap stocks are those ranked between 101 to 250 while small cap stocks are those whose rank is from 251. The fund can choose the amount of money that needs to be invested in each of these categories and the category that can be part of the equity portion of the portfolio. In other words, the proportion of these stocks in Multicap funds was at the discretion of the fund manager.
What are the new rules for Multicap funds?
SEBI has said in the circular that fund houses will now need to invest a minimum of 75% of their AUM in equities. So, that’s an upfront increase of 10% in equity allocation. This will not have any impact on Multicap funds as most of them invest more than 85% of their AUM in equities. For instance, Kotak Standard Multicap Fund invests more than 98% of its AUM in equities.
Now, the game changing rule laid down by SEBI is that there should be a minimum allocation of AUM in each category of market capitalization. This minimum allocation needs to be 25%. So, Multicap funds will now have to invest at least 25% of their AUM in each of large cap stocks, mid cap stocks and small cap stocks. Why has SEBI introduced this change? SEBI has said in the circular that most Multicap funds have more than 80% of their AUM in large cap stocks making them large cap funds. It also said that for most Multicap funds exposure to small cap stocks was in single digits. For instance, Kotak Standard Multicap Fund has 66% of its assets in large cap, 23% in mid cap stocks and only 1.5% in small cap stocks. Let’s consider another fund. The Motilal Oswal Multicap 35 Fund has 68% in large cap stocks, 15% in mid cap stocks and 5% in small cap stocks. So, Multicap funds are not actually Multicap funds. They seem to be mostly large cap funds.
The other point is that there seems to be no diversification across market cap categories for some of the Multicap funds. For instance, HDFC Equity Fund, which is supposed to be a Multicap fund, has almost 83% of its AUM in large cap stocks. This means that there is no diversification provided by the fund manager.
The third most important point that SEBI noted is that the benchmark used by the Multicap funds is not consistent with the portfolio composition of the schemes. Multicap funds seemed to be using benchmarks such as Nifty 200 or Nifty 500 that are more relevant for mid and small cap funds while Multicap funds invested mostly in large cap funds.
SEBI has said that all existing Multicap funds will need to comply with mentioned provisions within one month from the date on which the Association of Mutual Funds in India (AMFI) publishes the next list of large, mid and small cap stocks. So, the timeline will be January 31, 2020 for all the Multicap funds.
Now, what are fund houses doing about this?
Fund houses have requested SEBI to create a category of funds called Flexicap. This is to provide flexibility to the fund manager to invest in any of the market cap categories based on the markets. As you might know, for some years, large cap stocks may do well while in others, mid and small caps do well. Flexicap funds, if introduced, will help fund managers capitalise on the markets. If SEBI accepts the proposal, investors can invest in Flexicap funds.
If SEBI doesn’t agree, fund houses need to merge Multicap funds with other categories such as large cap or mid cap funds. Fund houses may make them thematic funds also.
It is good to take stock of your mutual fund investments to see if you have any Multicap stocks and whether the fund’s portfolio is getting changed.
Team at Wealthzi.com can review your existing portfolio, and suggest a way forward.
