New SEBI rule on Multicap Mutual Funds – Should Multicap Fund investors exit?




New SEBI rule for Multicap Mutual Funds – Should the investors exitFew days back SEBI has come up with new rules for asset allocation in multicap mutual funds which created lots of confusion among mutual funds investor community. SEBI clarified few pointers on September 14, 2020 again, but it could not stop investor nervousness. The new rules on asset allocation in multicap funds would definitely create confusion and there are greater chances that investors might stay away from multicap mutual funds going forward. In this article we would indicate SEBI’s new rule on asset allocation in multicap mutual funds and how it would impact investors going forward. We would also detail what other strategies you can adopt going forward.

Also Read: Top Performing Multicap Mutual Funds in India

What are multicap mutual funds?

You can skip this section if you are already aware.

Multicap mutual funds, also known as diversified mutual funds would invest across large cap, midcap and small cap segment. Due to this investment strategy, there is wider scope of investment options available for fund managers. Generally, multicap funds can invest a minimum of 65% of the portfolio in large cap, midcap and smallcap stocks and balance in debt instruments depending on the investment objective of the fund.

What is the SEBI new rule on multicap mutual funds?

SEBI has brought a new rule on the asset allocation in multicap mutual funds which made its mandate for funds to invest 75% in large cap, midcap and smallcap in equal portion. Here is how the new rule on asset allocation would be

1) Minimum of 25% of the portfolio should be invested in large cap stocks.

2) Minimum of 25% of the portfolio should be invested in midcap stocks.

3) Minimum of 25% of the portfolio should be invested in small cap stocks.

They have to mandatorily invest a fixed portion in largcap or micap or small cap stocks, whether fund managers like it not.

Let explain with example – Parag Parikh Long Term Equity Fund

Let us take one example.

1) Parag Parikh long term equity fund is a multicap mutual fund

2) Currently it has invested 52% in giant stocks + 18% in large cap stocks = 70% in the large cap segment

3) It invested 22% in midcap segment

4) It invested 8% in the small cap segment.

If you observe it has invested a higher portion in large cap stocks and lower portion in the small cap segment. If it has to adhere to SEBI new rule and remain as multicap fund, it has to reduce its exposure in large cap or giant stocks from 70% to 50%. It has to increase small cap stock portion from 8% to 25% and increase midcap segment from 22% to 25%. Fund has to adhere to this rule whether fund manager would like it or not.

Would all multicap mutual funds need to adhere to this rule?

Here are the guidelines of SEBI rule on multicap funds.

1) Multicap funds need to adhere to this new SEBI rule from January 31, 2021 by doing appropriate asset allocations.

2) Fund house can change category of multicap funds into other categories (e.g. focused funds, value funds, largecap funds etc.,) if required.

3) Fund houses can merge multicap funds with existing mutual funds.

4) Multicap funds can allow investors to switch to other funds without any exit load.

New SEBI rule for Multicap Mutual Funds – Should the investors exit?

Here are few thoughts.

1) These multicap funds need to invest a minimum of 25% in midcap and 25% in smallcap (totaling to 50%) going forward. Means these would become high risk mutual funds in the coming months. If you are NOT a high risk investor (especially if you have planned for retirement in the near future), you should exit such mutual funds. You can move your portfolio to either some of the good largecap funds or to any other appropriate category suitable based on your risk appetite and goal.

2) These funds may re-categorize from multicap funds to any other category that may be appropriate to such fund like value funds or focused fund. Now the fundamentals of the fund itself would get modified. Means the performance of the fund in future might be different as the composition and strategy would change for sure. Past performance would be IRRELEVANT in such case.

3) Some investors are comfortable to invest in large cap and midcap, however, not okay to invest in small cap funds. In such case, switching to largecap-midcap funds would be appropriate.

4) Investors should not jump into conclusion that multicap fund managers would increase their stake in small cap stocks and there could be a sudden rise in small cap stock prices. While it is bound to happen that fund managers might invest in small cap stocks with this new SEBI rule, if such stocks are over priced and cannot expect good returns.

Conclusion: Investors need to wait for a few more weeks before taking any decision. Mutual fund houses may appeal SEBI about this change or SEBI might come up with any relaxing guidelines. Once we get clarity, investors can take decision either to continue to stay or switch to other mutual fund schemes.

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Suresh KP

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