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SEBI's new Multicap Fund Directive - What should we understand & do?

Yesterday, stock market regulator SEBI has issued a new circular regarding multicap funds. According to the circular, in short, SEBI has mandated all Multi-Cap Equity funds to (re)allocate minimum 25% to each of Large Cap, Mid Cap and Small Cap categories of stocks, in less than 6 months time from now. At present multicap funds have much smaller allocations to mid caps and minuscule allocation to small cap stocks.

This news has created a buzz in the market. 

For sure this will result in lot of money moving from large caps to mid caps and small caps. Small caps will have higher inflows as multi cap fund hold very little small cap for now. So much sudden (over less than 6 months) flow in small cap stocks is a windfall. Small cap stocks category may not have that much depth to absorb so much sudden influx of money without causing unreasonable stock price appreciation, which makes the entire category more riskier.

On the other hand, this should correct last 3 years  market anomaly of being skewed towards very few heavyweight large caps. [Its notable here, that in the past when SEBI issued scheme recategorization circular, it had reverse effect - money moved from mid & small caps to large caps. That has partly became a reason for crash in mid & small cap stocks during 2018.]

However, this is happening when overall stock market is disconnected from economic reality and visibly has run-up too much disregarding Covid brought economic crises. During this time, actually all stocks rallied including small & micro cap stocks and even penny stocks of petty companies. Smaller companies are more susceptible to economic downturn. Covid brought demand destruction, financial stress, supply disruptions and market distortion should be death knell for many SMEs, which usually run with thin reserves and resources. As seen in the past mayatimes including recent the one in March, if market crashes, smaller companies stocks crash more than the large caps.

So, now the dilemma is, should tactical asset allocation be done (reducing equity allocation) or tactical diversification (reducing large cap allocation / increasing mid & small cap). Then its not a rosy scene in the debt market as well. While the price of the companies stocks are soaring, the very companies are busy getting govt. packages, loan guarantees, loan restructuring and moratorium. Govt's public debt is also ballooning while tax revenues are struggling to come back to normalcy and covid rage is taking toll on public healthcare expenditure and smooth and usual functioning of the Govt and the economy. India and India Inc (Indian Companies and their corporate debt) are facing the risks of downgrades.

I'll let you (my clients) know the proposed changes, if any, very soon, as I've done in the past. If I don't, consider I haven't decided anything yet or decided to remain undecided or decided to take no action. 

PS: SEBI has, after receiving overwhelming reactions and feedback, clarified that it shall allow the Fund Houses to keep the scheme mandates (investment objective) of Existing Multi Cap Schemes the same way by classifying them under a new category called "Flexi Cap" and renaming the schemes inline, accordingly. Flexi cap can have unequal and flexible (not fixed) allocations to Large, Mid and Small Cap Stocks. Any scheme continuing with "Multi Cap" category / name should align to the new rules / circular (as mentioned in the above article).

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