Inflows into small-cap funds have increased by 92 per cent in the first 10 months of this fiscal to ₹37,360 crore against ₹22,103 crore logged in the whole of last fiscal, leading to SEBI concern about a froth in the market.

Apart from this, most small and mid-cap mutual fund schemes have enhanced cash holdings as they could not find an investment opportunity at the right valuation.

Following the Securities and Exchange Board of India (SEBI) diktat, the Association of Mutual Funds in India (AMFI) has asked MFs to make more disclosures on these schemes and put in place a policy to protect investors interest in 21 days.

The overall AUM of small-cap funds increased by 89 per cent to ₹2.48-lakh crore in January compared with ₹1.31-lakh crore registered in the same period last year, while that of mid-cap funds was up 58 per cent at ₹2.90-lakh crore (₹1.83-lakh crore) in the same period, according to the AMFI data.

Nirav Karkera, Head of Research at Fisdom, said, “while the SEBI move will enable investors to make more informed decisions, there may be a limited impact on aggregate flows, while few investors may rotate investments based on new disclosures.”

New small-cap stocks

While the inflows and returns have increased multi-fold, the number of new small-cap stocks added to the portfolio of small-cap funds was up by 78 to 506 as of December-end compared to 428 in December 2022, said the Fisdom Research report.

Similarly, the addition of new mid-cap stocks to the portfolio was just 5 to 140 in the same period, it added.

Abhjit Bhave, Managing Director and CEO, Equirus Wealth, said, “While SEBI’s attention underscores the need for vigilance, it is important to recognise that the appeal of these segments often lies in their potential for growth and diversification.”

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“Investors should approach with caution, ensuring alignment with their risk tolerance and investment objectives,” he added.

Prashant Narvekar, Head (Sales), Smart Invest, a leading MF distributor, said, “Though inflows into small and mid-cap may taper a bit, investors will continue to chase these funds for high returns and not shy away till there is a sharp fall in stock prices.”

“The fewer stock additions to the portfolio reflect the concentrated investment strategies and reflect the regulator’s concern for froth,” he added.

Protecting interests

Large mutual fund houses have been proactively restricting inflows to protect investors interests.

SBI Small Cap Fund, which had capped SIP at ₹25,000 per month in 2018, has been holding cash and treasury-bill investments of 16 per cent. The fund has an AUM of ₹24,862 crore.

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Similarly, HDFC Small Cap, which has an AUM of ₹28,607 crore, has a 10 per cent investment in cash and T-bills. Nippon India Small Cap Fund, with assets of ₹45,894 crore, has a limited SIP of ₹5 lakh per day.

While mutual funds have done their bit by restricting inflows, Narvekar said the regulator can provide a safety net by easing the investment norms of small and mid-cap funds by reducing the mandatory 65 per cent exposure to stocks from these segments.