Should investors exit multicap mutual funds after new SEBI rule?

Last Updated on September 14, 2020 at 12:36 pm

SEBI was forced to release a press release on 14th Sep 2020 after its Sep 11th circular change in multicap fund asset allocation caused concern about fall in large caps in the coming days. SEBIs unnecessary change has lead investors to ask if they should consider an exit from multicap mutual funds.

The Sep 14th press release does not help calm investor nerves in any way. SEBI remained defiant in its justification for mandating 25% minimum exposure to 25% in large cap (top 100 stocks in terms of market cap), 25% mid cap stocks (101st to 250th) and 25% small cap stocks (25th and below).

It has only clarified something well known to AMCs – instead of rebalancing an existing mutual fund portfolio by selling large cap stocks and buying more of mid caps and small caps (not immediately but by Feb 2021), fund houses could (1) merge their multicap funds with other funds (2) change category or (3) allow investors to switch funds without load.

All this does not change the fact that SEBI’s sudden rule change three years after it was originally announced does not help unitholders in any way. SEBI must appreciate that many investors do not mind if their multicap funds are large cap heavy with the freedom to change the allocation at will. A multicap fund with a large helping of large caps, a dollop of mid cap caps and a pinch of small caps are what would keep most investors calm regardless of market conditions.

A 25% mid cap and small cap allocation at all times will make funds extremely volatile and unwieldy as explained before: How SEBI’s Multicap MF asset allocation rules will affect investors. It could also necessitate inflow closure depending on market valuation to protect existing unitholder interests.

SEBI’s press release has this baffling statement: “Multi Cap schemes had flexibility in terms of allocation to Large, Mid and Small Cap stocks. However, it has recently been observed that some Multi Cap Schemes have skewed portfolios, with over 80% of investment in large cap stocks akin to Large Cap schemes, and some Multi Cap schemes have near zero or insignificant asset allocation to small cap companies”

SEBI definition of “flexibility” is arbitrary. If the regulator thought it important that these funds “should have smallcap exposure” then why allow this “flexibility” three years ago? Why wait so long for investors to get used to the new scheme categories, introduce an arbitrary limit and then post a release saying they do not want to create disruption in the markets!

SEBI has done what a regulator should never do – cause investors confusion and worry. Yes they have given fund houses enough time to comply but with social media frenzy on even trivial matters, it only increases investor stress. The scheme categorization rules were far from perfect from day one. Arbitrary changes like this only make things worse. A 10% allocation to small caps at times is significant enough and would have not caused this much confusion.

Should investors exit multicap mutual funds?

Fund houses value AUM. So they would do everything in their power to ensure investors stay put. You can expect large multicap funds to change category. First, they are likely to appeal to SEBI. If that does not work, they will either comply or change category. Either way, once the compliance circular is published a time window of one month would be given to exit without load. Therefore investors should wait at least until the circular to make a decision. There is no need to act in haste now.

Many investors are worried if this circular would affect ELSS mutual funds and other categories. It will not. Also, investors in Parag Parikh Long Term Equity Fund have wondered about its fate. As mentioned my Sep 202o portfolio update (see video linked below) this fund occupies 44% of my retirement portfolio.

If the fund house remains a multicap fund, mid cap and small cap allocations would increase by about 10% each (as per Aug factsheet) and large cap and international equity allocation would see a corresponding decrease. This will increase fund volatility. At my age and retirement planning stage, that might not be acceptable. So at the very least, if the fund remains a multicap (assuming the 25% ruling stays) I will have to reduce exposure. A younger investor need not do this.

In summary, please take a case-by-case decision. There is no hurry. Maybe SEBI could modify the rule or AMCs could protect unitholder interests by changing category.

O, that a man might know
The end of this day’s business ere it come!
But it sufficeth that the day will end,
And then the end is known. – Julius Caesar Act 5 Scene 1