Combative mutual funds may dash small-cap party hopes

MUMBAI: The weekend celebrations of investors in small-cap stocks over the capital market regulator's stricter investment norms for mutual funds' multi-cap funds-a product with a mandate to invest across share categories-- may prove to be premature. Mutual funds are looking at various possibilities that would help multi-cap schemes avoid forced purchases of small- and mid-cap stocks to comply with Securities and Exchange Board of India's new rules for this product category that requires minimum investments in bluechips, mid-caps and small-caps.


Fund officials told top distributors and investment advisors on Saturday that Asset Management Companies would look to merge multi-cap funds into large- and mid-cap schemes. Multi-cap schemes have invested majority of the corpus in large-cap stocks.


The regulator on Friday evening asked multi-cap funds to invest at least 25% of their corpus each in large-cap stocks, mid-caps and small-cap stocks, sparking sharp protests in the industry. Currently, there are no investment restrictions for this category.

The other option AMCs would consider is converting multi-cap schemes into thematic schemes, which do not have investment restrictions. The last option would be to close down the multi-cap schemes and return the money to investors. These decisions will depend on Sebi’s approval.

“We can return the money to unitholders, we can request them to switch to our other categories of funds, we can consider merging of schemes etc to ensure that investor interests aren't compromised,” said Nilesh Shah, MD, Kotak Mutual Fund, which manages the largest multi-cap fund of almost Rs30,000 crore, told ET. “We will comply with Sebi guidelines in letter as well as spirit.” The regulator has asked fund houses to comply with the new norms by January 31.

The mutual fund industry is not in favour of multi-cap schemes raising exposure to small-cap stocks on the grounds that the rush to buy them would be detrimental to unitholders of these schemes. Fund managers in these schemes have preferred blue-chips or larger mid-cap stocks of late because they are in a better position to weather the economic slump than smaller companies.

Meanwhile, investors in small- and mid-cap companies are enthused by the new norm because most multi-cap schemes' exposure to these stocks have been way below the minimum investment requirement of 25%. Small-cap investors are betting the reshuffling of the multi-cap portfolios, which manage investors' money worth Rs1.46 lakh crore or 20% of the industry's equity Assets Under Management, could lead to a flood of money into these lesser-known illiquid stocks.

“Street expectations of potential buying by mutual funds in small and mid-cap are unlikely to be met unless it is going to make money for our unitholders,” said Shah. “We will buy a stock only if it makes sense for our investors. Let there be no doubt about it.”