In a circular dated Sep 11th 2020, SEBI has modified asset allocation rules for multicap mutual funds. We discuss how this rule is unnecessary and is likely to affect investors.
The initial scheme categorization circular issued in OCt 2017 only wanted a multicap fund to maintain 65% equity exposure with no other regulation on market cap allocation. Now SEBI has modified the asset allocation rules “in order to diversify the underlying investments of Multi-Cap Funds across the large, mid and smallcap companies and be true to label”
Now there will be a minimum 75% equity exposure with 25% in large cap (top 100 stocks in terms of market cap), 25% mid cap stocks (101st to 250th) and 25% small cap stocks (25st and below).
Mutual funds have time until Feb 2021 to comply with this rule. Although there is no immediate disruption, this rule will make multicap mutual funds significantly more volatile. On the other hand, singular cases of outperformance, that is one fund alone doing better than the rest, will reduce. So it is definitely a good move for potential future investors in the multicap space.
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Large Cap Allocation in Multicap Fund (Aug end 2020)
| Scheme Name | Allocation (%) |
| Axis Multicap Fund | 92.3 |
| Motilal Oswal Multicap 35 Fund | 88.9 |
| JM Multicap Fund | 88.1 |
| HDFC Equity Fund | 85.9 |
| Taurus Starshare (Multi Cap) Fund | 82.8 |
| Sundaram Equity Fund | 79.8 |
| BNP Paribas Multi Cap Fund | 78.7 |
| Franklin India Equity Fund | 78.1 |
| ITI Multi-Cap Fund | 77.7 |
| Kotak Standard Multicap Fund | 77.7 |
| HSBC Multi Cap Equity Fund | 76.9 |
| Essel Multi Cap Fund | 75.3 |
| ICICI Pru Multicap Fund | 75.0 |
| Canara Rob Equity Diver Fund | 74.6 |
| Edelweiss Multi-Cap Fund | 73.9 |
| Baroda Multi Cap Fund | 73.5 |
| L&T Equity Fund | 73.0 |
| SBI Magnum Multicap Fund | 72.9 |
| Union Multi Cap Fund | 72.7 |
| Shriram Multicap Fund | 71.4 |
| DSP Equity Fund | 70.1 |
| LIC MF Multi Cap Fund | 70.0 |
| Principal Multi Cap Growth Fund | 69.9 |
| Mahindra Manulife Multi Cap Badhat Yojana | 69.0 |
| Aditya Birla SL Equity Fund | 68.2 |
| IDBI Diversified Equity Fund | 68.0 |
| Tata Multicap Fund | 67.8 |
| UTI Equity Fund | 65.8 |
| PGIM India Diversified Equity Fund | 62.1 |
| IDFC Multi Cap Fund | 53.4 |
| Nippon India Multi Cap Fund | 53.1 |
| BOI AXA Multi Cap Fund | 46.4 |
| Invesco India Multicap Fund | 35.2 |
| Parag Parikh Long Term Equity Fund | 34.9 |
| Quant Active Fund | 18.0 |
Except for a few mutual funds, most of them are essentially large cap funds. Superficially it is easier to argue that a multi-cap fund should have equal representation across the market cap. However, if we restrict the fund managers ability to change cap weights we guarantee higher risk and also lower potential reward.
SEBI could have set the minimum exposure to 10% to each segment and leave the rest to the fund managers discretion. A fund can invest a maximum of 90-95% in equity. So with a minimum 25% exposure in each segment, the fund manager only has the freedom to the extent of 15-20% (much less if cash calls are made) to change the cap weights.
This is not bad for a new investor (they would get used to this from day one) but it would certainly be a “new normal” for existing multicap investors. Additionally, funds with large AUM will find compliance difficult. They may switch avatars to become large and midcap funds. A fund like Parag Parikh should be able to adjust to this, in my opinion.
AUM of multicap mutual funds (Aug-end 2020)
| Scheme Name | AUM(Cr) |
| Kotak Standard Multicap Fund(G) | 29714.07 |
| HDFC Equity Fund(G) | 19797.98 |
| Motilal Oswal Multicap 35 Fund-Reg(G) | 11239.87 |
| Aditya Birla SL Equity Fund(G) | 11023.35 |
| UTI Equity Fund-Reg(D) | 10982.95 |
| SBI Magnum Multicap Fund-Reg(G) | 9063.31 |
| Franklin India Equity Fund(G) | 8591.33 |
| Nippon India Multi Cap Fund(G) | 8053.29 |
| Axis Multicap Fund-Reg(G) | 6434.07 |
| ICICI Pru Multicap Fund(G) | 5593.74 |
| IDFC Multi Cap Fund-Reg(G) | 4847.02 |
| Parag Parikh Long Term Equity Fund-Reg(G) | 4508.14 |
| DSP Equity Fund-Reg(D) | 3725.93 |
| L&T Equity Fund-Reg(G) | 2366.46 |
| Canara Rob Equity Diver Fund-Reg(G) | 2280.01 |
| Tata Multicap Fund-Reg(G) | 1694.77 |
| Invesco India Multicap Fund(G) | 924.83 |
| Baroda Multi Cap Fund(G) | 825.16 |
| Principal Multi Cap Growth Fund(G) | 653.54 |
| Sundaram Equity Fund-Reg(G) | 600.31 |
| Edelweiss Multi-Cap Fund-Reg(G) | 559.97 |
| BNP Paribas Multi Cap Fund(G) | 555.01 |
| Union Multi Cap Fund-Reg(G) | 370.74 |
| Mahindra Manulife Multi Cap Badhat Yojana-Reg(G) | 340.20 |
| HSBC Multi Cap Equity Fund(G) | 330.26 |
| LIC MF Multi Cap Fund(G) | 294.78 |
| IDBI Diversified Equity Fund(G) | 289.51 |
| PGIM India Diversified Equity Fund-Reg(G) | 225.60 |
| Taurus Starshare (Multi Cap) Fund-Reg(G) | 200.17 |
| Essel Multi Cap Fund-Reg(G) | 176.42 |
| ITI Multi-Cap Fund-Reg(G) | 134.42 |
| JM Multicap Fund(G) | 130.88 |
| Shriram Multicap Fund-Reg(G) | 58.47 |
| BOI AXA Multi Cap Fund-Reg(G) | 40.28 |
| Quant Active Fund(G) | 35.80 |
Take Kotak Standard Multicap. If the fund manager needs to shift 25% of its AUM to small caps, it would amount to Rs. 7400 Crores. Currently, only HDFC Small Cap Fund and Nippon Indian Small Cap funds have a higher AUM in that segment!
It would be best if Kotak AMC changes the fundamental attribute of the scheme. Similar arguments would apply to other heavyweights like HDFC Equity or any fund with Rs. 10,000 Crores or more. Whether they choose to change type or not remains to be seen though.
Experienced investors know that as the AUM of a fund increases, the fund manager tends to go heavy on large caps. The reason for this is their higher liquidity and ability to handle sudden in or outflows. Existing multicap fund investors need not panic. Please wait for clarity from the fund house.
In summary, existing multicap investors must brace for higher volatility and extended periods of poor returns if the mid and small cap segments alone underperform. Diversification comes with a price!
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