Multi-cap funds are not complicated structures. In fact, there was only one condition.
Multicap funds needed to have a minimum of 65% of their assets invested in equities at any given time. This means the fund manager was free to decide how much of the scheme assets were going to large-cap companies, mid-cap, and small-cap companies.
Now, SEBI defines a large-cap company as those listed companies which are ranked from 1st to 100th company in the Indian stock exchanges in the terms of market capitalization. Mid-cap companies are ranked from 101 to 250 in terms of market capitalization and small-cap companies start from the 251st ranked company. A list of these companies is available on the Association of Mutual Funds in India (AMFI) website.
Now, this flexibility of choosing how much money was going to which company and which type of company i.e. a large, mid or small-cap is what fund managers love as it allows them to take the most optimum investing decisions on behalf of the investors.
So, what are these changes that SEBI has introduced?
Here are the 2 New SEBI Rules For Multicap Fund
Number 1: Minimum allocation to equities was increased from 65% to 75%
As we mentioned earlier, that there was only one condition for Multi cap funds and that was 65% of their money should be invested in equities. Well, that’s changed and now at least 75% of the assets in a Multi cap fund need to be invested in equities at all times.
This change won’t have a major issue, because Multi cap funds are generally invested in equities most time. For example, the biggest fund in the category, Kotak Standard Multi cap Fund, which has over 97% of its assets invested in equities. So this is not the problem.
Number 2: Defined minimum allocation in each market capitalization
The change in the SEBI circular regarding allocation is making everyone’s head spin.
Earlier, the fund managers were free to choose in which companies they’d like to invest in without any restriction on whether they are large, mid, or small-cap companies.
However, as per the September 11 circular, all Multi cap funds are to necessarily invest at least 25% of their portfolio in each capitalization category. This means at least 25% each in large-cap companies, mid-caps, and small-cap companies.
So why has the SEBI come out with these modified scheme characteristics?
So, these are the three areas of concern that SEBI has raised in their clarification.
#1: The lack of noteworthy diversification in most Multi-Cap Funds
SEBI says that they have enforced this 25:25:25 allocation upon the observation that many Multi-Cap Funds have over 80% of their investment in large-cap stocks which makes them more like large-cap funds rather than Multi cap funds. They further added in the clarification that the share of small-cap companies is in the lower single digits in some of these schemes.
We looked at the top 5 Multi cap funds per their assets under management to understand whether it is true.
| Composition of large, mid and small cap stocks in the top 5 Multi cap funds (by AUM) | |||
| Large Cap Stocks | Mid Cap Stocks | Small Cap Stocks | |
| Kotak Standard Multicap Fund | 76% | 22% | 2% |
| HDFC Equity Fund | 88% | 8% | 4% |
| Motilal Oswal Multicap 35 Fund | 86% | 10% | 4% |
| Aditya Birla Sun Life Equity Fund | 70% | 24% | 6% |
| UTI Equity Fund | 60% | 32% | 8% |
SEBI has a point with none of the top 5 schemes having more than 8% of their portfolio in small-caps.
#2: Divergence in the name and the nature of the scheme
HDFC Equity Fund and the Motilal Oswal Multi cap 35 fund has over 85% of their portfolio in large-cap companies with little or no diversification into mid and small-cap funds. So from the SEBI point of view, the name of the scheme and the nature of the scheme is completely at opposite ends and bordering on being misleading.
#3: Use of appropriate benchmarks
The SEBI has also made note of the benchmark that is used by the Multi cap funds is not in line with the composition of these schemes. That’s because the appropriate benchmark for large-cap funds is the NIFTY 50 while the benchmarks used by Multi cap funds are NIFTY 200 or NIFTY 500.
But, the opinion of the AMCs differ from SEBI’s point of view, and here is what most of the AMCs we spoke to had to say on these observations
Fund Houses’ Response to SEBI’s observations
#1: Counter argument: The lack of noteworthy diversification in most Multicap funds
The fund houses feel that the entire point of opting for Multi cap funds is to have the flexibility of moving between capitalization categories depending on present market conditions, future market outlook, and valuations.
Diversification can be done using other tools like having a mix of large, mid, and small-cap funds in one’s portfolio but the objective of a Multi cap fund for investors is to build long term wealth.
Over the last three years, large caps and mid/small caps have moved in waves. For example, small and mid-cap companies were grossly overvalued in the last quarter of 2017 and many of them lost 20-30% in value over the next 12 months. Similarly, many investors feel that large-cap companies are overvalued now as the Nifty PE Ratio hangs around 32. This is when flexibility in changing track becomes more important than diversification
#2: Counter argument: Divergence in the name and the nature of the scheme
On the point related to the divergence in the name and the nature of the scheme, it again seems to be a point of view issue. While SEBI looks at the word “Multi cap” as the components of the fund, the investors might be viewing the name around the flexible nature of the fund.
Now, maybe if the name was Flexicap rather than Multicap, the issue of the name being misleading might not have come across.
#3: Counter argument: Use of appropriate benchmarks
We mentioned earlier that Multi cap schemes use the Nifty 200 or the Nifty 500 as benchmarks. Let’s take the Nifty 500 as the benchmark for this discussion.
Now, we looked at the composition of the Nifty 500 in terms of large, mid, and small-cap stocks. Here’s what I found:
- Large-cap stocks composition in Nifty 500 is 78%
- Mid-cap stocks composition is 17%
- Small-cap stocks composition is 5%
As you can see, while the benchmark is 78%, 17%, and 5%, SEBI wants these funds to mimic a 50%, 25%, 25% split. In other words, SEBI’s contention of having an appropriate benchmark seems to be going against their own words.
So, what’s next?
Now that we have seen the views of the regulator and the fund house, let’s look at the many options available to the mutual fund companies.
SEBI in their clarification note has hinted at some options. These include:
- Mutual fund Multi cap schemes can rebalance their portfolio wherein most have to add to small and mid-caps and divest from some of the large-cap stocks in their portfolio
- Funds can merge their Multi cap scheme with another scheme like a large-cap scheme or a large and mid-cap scheme.
In addition to what SEBI says, some fund houses have hinted at converting the Multi cap fund into a thematic fund or a focused equity fund where there are no or low restrictions on market capitalization. SEBI has given until January 2021 to the mutual fund companies to make the requisite changes.
It is highly unlikely the fund houses will make this change as this would not be an easy task plus it will change the risk-return profile of the funds.
What should you do as an investor in Multi cap funds?
Firstly, wait. It’s not even been a week since the announcement. So allow the news to sink in with all stakeholders including the regulator and the mutual fund companies. SEBI has already come out with a clarification and one can expect all mutual fund houses to release some communication regarding their views and actions pertaining to this circular.
.The second thing you should do is to have a clear oversight on what proportion of your portfolio is in large, mid, and small-cap companies. While there is a rejig in the composition of Multi cap funds, you need to know how it fits in with your overall portfolio. You can easily do this with the ETMONEY app which gives you the percentages of your holdings in large, mid, and small-cap companies.
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