Most of my current SIPs are in multi-cap equity funds such as Kotak Standard Multicap and Parag Parikh Long Term Equity. I was advised that this category is the best for long-term wealth creation as it invests in stocks across market-caps. But after a SEBI circular in September, I read that multi-cap funds will have to shift a larger portion of their portfolio into small-cap and mid-cap stocks to make up at least 25 per cent of the fund. Now, I see many funds are announcing that they will change into flexi-cap funds. What should I do? Should I stop SIPs in my multi-cap funds and consider some other categories such as large- and mid-cap or focussed funds?

Saravanan N

If you have started SIPs in multi-cap funds after studying their portfolios and understanding their return and risk, you need not take any action. SEBI’s main concern when it issued the September circular was that investors would be misled into thinking that multi-cap funds would maintain a constant and sizeable allocation to mid-cap and small-cap stocks at all times.

In practice, most multi-cap funds substantially vary their allocations between large-, mid- and small-cap stocks.

In the last couple of years, the leading muti-cap funds have held high allocations to large-cap stocks, amounting to nearly 70 per cent of their assets, for two reasons. One, with overall market valuations getting quite expensive, fund managers have sought safety in the relatively better-known names in the market. Two, when fund sizes get very large (₹10,000-crore plus), both building and liquidating positions in mid- and small-cap stocks become doubly difficult.

When very large-sized multi-cap funds try to acquire meaningful positions in small-caps, this can cause stock prices to move sharply, impacting fund returns. Liquidating such positions can also depress the price as liquidity in small-caps can dry up quickly in bear markets or during market falls.

Given these challenges, SEBI’s multi-cap fund circular puts the larger funds in a tight corner. Having gone overweight on large-cap stocks over the last couple of years, fund managers would have had to shift a substantial portion of their assets into mid- and small-caps before January to be compliant. This could have led to a rush for better-quality small-caps, bidding up their already high valuations.

This would not have augured well for their long-term performance.

SEBI’s latest circular on November 6, allowing AMCs to launch a new flexic-ap equity category, with existing schemes allowed to rebrand themselves, offers a way out.

Multi-cap funds that are unable to comply with SEBI’s earlier rule of investing a minimum of 25 per cent each in mid- and small-cap stocks can now rename themselves as flexic-ap funds. But first they will have to offer their existing investors an exit option (without load).

CEOs of Parag Parikh AMC and Kotak AMC have made social media announcements that their flagship multi-cap funds would be converted into flexi-cap funds, with minimal changes to the portfolios or the fund strategy. This will be followed up by official communication.

Do watch out for such announcements in your other multi-cap funds. If they decide to opt for the flexi-cap category, it is likely that you will not see much change in their mid- or small-cap allocations in the coming months. If you are comfortable with status quo, you need not respond to the communication.

However, if you invested in multi-cap funds with the intent of owning sizeable mid- or small-cap exposures, then flexic-ap funds may not serve the purpose.

While lower mid-cap and small-cap allocations do lower the risk profile of a fund, they also lower its return potential.

Many fund managers, for instance, did miss out on the stellar rally in small-caps between March and now.

Risk-taking investors who want constant small-cap exposure can look out for funds that retain the multi-cap label , or add a fixed allocation to dedicated small-cap funds.

Send your queries to mf@thehindu.co.in

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