Good intent, bad planning

The Securities and Exchange Board of India’s (SEBI) move on changing asset allocation in multi-cap mutual funds may be well intended. It is aimed at making these funds ‘true to label’ and broad-basing trading activity in the market and improving volumes in small-cap stocks. But the implementation and timing leave much to be desired. Stipulating that these funds allocate 75 per cent of the assets in equity of which 25 per cent each should be invested in large, mid and small-cap stocks and that too within a short timeframe could lead to multiple problems. It is unfair to investors who have parked money in these funds based on their current investment strategy. Re-allocation of assets according to the new mandate would have resulted in spiking the demand for small-cap stocks, driving up their prices. The regulator has, however, assuaged sentiments somewhat by offering other options to funds besides rebalancing the assets and by showing willingness to reconsider its decision.

If SEBI wanted multi-cap funds to invest according to their label, it should have laid down the sub-limits in 2017 when all other mutual fund schemes were recategorised. At that time, SEBI had given ample flexibility to multi-cap schemes by not setting limits for each market cap, and stopping with the overall cap of 65 per cent for equity investments. Fund managers had used the flexibility to invest a bulk of the assets in large-cap stocks that appeared better placed to deliver sound returns to investors . Investors have also parked almost ₹1.5 lakh crore in these funds, believing that the fund managers will allocate their money across market capitalisation, depending on the prospects of each segment. A problem that fund managers will face is that small-cap stocks with good fundamentals and robust trading volume are limited. They are unlikely to be able to increase the allocation towards small-cap stocks to 25 per cent of assets, without harming investors’ interest. Also, the stock market is currently in a vulnerable state with heightened speculation driving up stock prices despite gloomy prospects for the economy and corporates. This is not the time to encourage trading activity in smaller, illiquid stocks.

SEBI has clarified that fund houses can allow investors to switch to other schemes, merge their multi-cap scheme with their large-cap scheme or convert their multi-cap scheme to another category. Besides these, the regulator can consider introducing another equity fund category, flexi-cap funds — that operate with the mandate of the extant multi-cap funds. This would cause the least disruption to investors as it would involve only change in the fund name. If the regulator intends to insist on asset re-allocation, a longer time should be given for re-balancing and the limit of 25 per cent towards small-cap stocks should be lowered. The regulator should desist from making piecemeal changes in rules that cause unnecessary upheavals in the market.