SEBI Issues New Rules For Multi-cap Funds. What Should The Investors Do?

SEBI’s rules for Multi-cap Funds: What should the investors do?

The Securities and Exchange Board of India (SEBI) introduced regulations that have significant implications for the Mutual Fund (MF) industry, particularly Multi-cap Funds. These funds, known for their flexible portfolio structure, are now subject to revised guidelines. The SEBI directive aims to strengthen the equity focus of Multi-cap Funds, requiring an increased minimum allocation to equities and a strict mandate for specific allocations across large-cap, mid-cap and small-cap categories. These regulations have sparked discussions within the community, with stakeholders expressing support and concerns.

The investment industry is dealing with significant changes due to the rules set by SEBI for Multi-cap Funds. These changes have raised various concerns about diversification, strategy and the direction of these funds. The revised regulations have brought the role of Mid-cap Investment Funds into sharper focus, prompting investors to reconsider their allocations in response to SEBI's directives. Given this ever-changing scenario, investors are now faced with the challenge of determining the best action to protect and optimise their investment portfolios.

Understanding the Pre-SEBI Rule landscape

Before we discuss the changes made, it is crucial to understand the regulatory framework governing the Multi-cap Funds that existed before these modifications. The regulations were simple, with Multi-cap Funds one was required to invest at least 65% of the assets in equities. Fund managers had the freedom to allocate assets among large-cap, mid-cap and small-cap companies depending on the current market conditions and the fund manager's outlook on market dynamics.

Before SEBI regulations, the emphasis was on Equity investments, including Mid-cap Investment Funds. Fund managers strategically distributed assets across large-cap, mid-cap and small-cap companies, adapting dynamically to the ever-changing equity market. The simplicity of these regulations facilitated adaptability, empowering fund managers to respond effectively to the market conditions, particularly in the Mid-cap investment segment. This flexibility allowed proper decision making with fewer differences, optimising portfolio performance within the broader equity spectrum.

SEBI's Rules - What has changed?

SEBI's circular brought two changes to the table:

• Increase in minimum allocation to the equities:

  The initial condition of 65% minimum allocation to the equities has been raised to 75%. This adjustment aims to reinforce the equity-focused nature of the Multi-cap Funds.

• Defined minimum allocation in each market capitalisation:

  The most impactful change mandates that Multi-cap Funds invest at least 25% of their portfolio in the three market capitalisation categories—large-cap, mid-cap and small-cap. This is a departure from the flexibility that existed earlier, which allowed the fund managers to allocate funds without specific restrictions.

Why did SEBI introduce these changes?

SEBI's decision to redefine the rules for Multi-cap Funds is based on a few key concerns.

• Lack of noteworthy diversification:

  SEBI observed that many Multi-cap Funds exhibited limited diversification, with over 80% of investments concentrated in Large-cap stocks, making them resemble as Large-cap Funds rather than true Multi-cap Funds.

• Divergence in scheme names and nature:

  Some Multi-cap Funds had a large portion of their portfolio in Large-caps, creating a mismatch between the scheme's name and nature.

• Use of appropriate benchmarks:

  SEBI observed that the benchmarks used by Multi-cap Funds (NIFTY 200 or NIFTY 500) were not aligned with the composition of these schemes. The appropriate benchmark for Large-cap Funds is NIFTY 50.

Reactions from the Asset Management Companies

Asset Management Companies (AMCs) responded with diverse opinions on SEBI's observations:

• Diversification concerns:

  AMCs have argued that the Multi-cap Funds are chosen for their flexibility in moving between capitalisation categories based on the market conditions, valuations and future outlook. They are of the opinion that the diversification can be achieved through a mix of different funds in an investor's portfolio.

• Scheme name vs flexibility:

  On the divergence in scheme names and nature, AMCs suggest that investors might view Multi-cap as indicative of the fund's flexibility rather than a rigid structure.

• Benchmark alignment:

  Some AMCs question SEBI's call for a 50%, 25%, 25% split when the benchmark (NIFTY 500) has a different composition (78%, 17%, 5%).

What's next for Multi-cap Funds?

SEBI issued a clarification note outlining several options for Mutual Fund companies.

• Rebalancing portfolios:

  Funds can rebalance their portfolios by adding to Small-cap and Mid-cap while divesting from some Large-cap stocks to comply with the rules.

• Merging schemes:

  Multi-cap schemes can be merged with the other schemes, such as Large-cap or Large and Mid-cap schemes.

• Conversion into thematic or focused Equity Funds:

  Some fund houses hinted at converting Multi-cap Funds into thematic or focused Equity Funds with fewer market capitalisation restrictions.

Investor action plan

In the current dynamic scenario, if you are an investor in Multi-cap Funds, it is recommended that you consider the following steps:

• Assess portfolio proportions:

  Investors need to clearly understand the proportions of their portfolios allocated to large-cap, mid-cap and small-cap companies. Financial apps can be valuable tools for a quick overview.

• Stay informed:

  Investors should stay informed about any updates or communications from the fund houses and regulators.

• Diversify strategically:

  Consider diversifying your investment strategy in response to the changes. Explore alternative funds or adjust your portfolio to align with the evolving market dynamics.

• Seek professional guidance:

  Consulting with the financial advisors can provide personalised insights and guidance for achieving financial goals, optimising investment strategies and navigating regulatory adjustments.

Conclusion

SEBI's rules for Multi-cap Funds have caused a stir in the investment landscape. However, investors must approach the situation with a level-headed perspective. The Mutual Fund industry will likely adapt to these changes and investors should stay alert, informed and patient. The key is understanding how these modifications align with the individual investment goals and adjusting the strategies accordingly. Investors should remember that being cautious and having a well-informed approach will be their best guide.