A recent circular from the Securities and Exchange Board of India (SEBI), released on the 11th of September, 2020 had completely changed the structure of multi cap funds. The notification received mixed responses with many hailing it as a good move while others questioning the said changes. Spurred by such an overwhelming response, SEBI clarified its stance through another notification on the 13th of September, 2020.

And subsequently, in a bid to put all concerns to rest, the SEBI had released another notification on the 6th of November, 2020 announcing the creation of another category of mutual funds – flexi cap. Let’s take an in-depth look at these SEBI regulations and try to understand the rationale behind such moves.  

SEBI regulation mandating the change in the structure of multi cap funds 

According to the circular released on the 11th of September, 2020, SEBI brought about two major changes in the way multi cap funds were structured.

  • The minimum fund allocation towards equities and equity-linked instruments in multi cap funds was increased to 75% from the erstwhile 65%.
  • Minimum fund allocation in each market capitalization category in multi cap funds to be at least 25%. This effectively means that multi cap funds should have a portfolio of not less than 25% in large cap, mid cap, and small cap companies respectively. 

Additional Read: With the new SEBI rules, are Multi-cap funds worth the risk?

Clarification issued by SEBI

Post the release of the above notification, many investors and Asset Management Companies (AMCs) were unclear about the reasons for this sudden change. Responding to their queries, the SEBI issued a clarification on the same, clearly stating the reasons for the change, as follows.

  • Since most multi cap funds possess an unfairly high percentage of asset allocation towards large cap companies, SEBI clarified that this change would promote equal distribution of funds across the three major capitalization categories. 
  • SEBI also said that this change would more accurately reflect the name of the scheme, thereby avoiding confusion for beginner investors.
  • And finally, SEBI was of the view that this change would encourage fund houses to use a more appropriate benchmark to disclose the fund performance.

Probable effects of this SEBI regulation

The above-mentioned SEBI regulation mandating a change in the structure of multi cap funds is likely to have a major short-term effect. Considering the fact that most multi cap funds possess around 70% to 80% of investments in large cap stocks, this change would force fund houses to rebalance their portfolio significantly. This would include liquidating their holdings in large cap stocks and investing the same in both mid and small caps.

Such a sudden move could cause a drop in the share prices of large cap companies due to the outflow of funds. Also, there’s likely to be a sharp rise in the share prices of mid cap and small cap stocks as a consequence of fund inflows.

SEBI Circular on Multi Cap Funds

Introduction of a new category of mutual funds: Flexi cap funds 

Taking cognizance of the many implications and short-term effects that such a huge move would bring about to the multi cap funds category, the AMFI and mutual fund houses suggested that SEBI create a new category of mutual funds – the flexi cap.

Upon acknowledging the concerns of investors, the AMFI, and mutual fund houses, SEBI took the suggestion made by them and launched the flexi cap category of mutual fund schemes vide a notification dated 9th November, 2020. Here are some of the significant pointers from this notification.

  1. Flexi cap funds are required to have a minimum of 65% of equity and equity-related investments as part of their portfolio.
  1. Additionally, with flexi cap funds, there’s no minimum limit to the fund allocation between large cap, mid cap, and small cap stocks. So, for instance, a fund house can choose to allocate around 95% of its funds to large caps alone, with the remaining 5% distributed between mid and small cap stocks. With the introduction of this category, SEBI has essentially brought the erstwhile flexibility that multi cap funds used to enjoy into the flexi cap category.

Additional Read: Is the SEBIs new Riskometer regulation

The road ahead for investors and fund houses

With the SEBI regulation mandating the structural change in multi cap funds and the introduction of the flexi cap category of mutual funds, fund houses with multi cap funds have two options in front of them.

  1. They can choose to rebalance their multi cap funds by liquidating their holdings in large cap stocks and redirecting them to both mid and small caps to bring the holdings up to at least 25% in each category.
  1. Or, they can opt to convert their existing multi cap funds into flexi cap funds according to the relevant rules and regulations laid out by the SEBI. If fund houses opt for conversion, they would only need to replace the names of their schemes from multi cap to flexi cap to reflect the change.

Conclusion

The SEBI regulation introducing this new category has been well-received by all the stakeholders. It is far easier for a fund house to simply convert their multi cap schemes to flexi cap instead of opting to rebalance their portfolio to meet the new multi cap requirements. And as such, investors can likely expect the same from their fund houses in the near future.  Whether it’s investment in Multi Cap or Flexi Cap, Tata Capital Wealth Relationship Managers are there to assist you in your investment journey.

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