Vijay Kumar Gaba

The last weekend was unusually hectic for most participants. Friday evening, the market regulator issued fresh guidelines for asset allocation by the mutual fund schemes operational under the "multicap fund" category. The guidelines specify that these mutual fund schemes must allocate at least 25% of assets under management to each of large cap, mid cap and small cap category of stocks. SEBI also directed that the minimum equity allocation of these funds shall be 75% (presently 65%) at any given point in time. The mutual funds are required to comply by these directions in six months, i.e., by February 2021. SEBI further clarified that these guidelines have been issued further to the guidelines regarding categorization and rationalization of Mutual Fund Schemes issued in October 2017.

It is pertinent to note that as per SEBI directions, top 100 listed companies in terms of market capitalization are categorized as Large Cap. Companies ranked 101 to 250 are categorized as Mid Cap and the others come under small cap category. As such, NMDC is 100trh ranked stocks with Market of Rs27500cr; P&G is 250th ranked stocks with Rs8100cr market cap. So stocks below Rs8100cr market cap are small cap stocks.

Over weekend most of the brokerages and AMCs came out with their views on the proposed changes. The brokerages' reports were mostly focused on two aspects" (i) how much money will have to be reallocated from large cap to mid and small cap stocks to comply with these guidelines; and (ii) which are the stocks that could see higher demand due to this reallocation exercise and what is the trade opportunity in this. The AMCs mostly focused on highlighting the challenges in compliance.

I am sure that any guideline followed or not followed by mutual funds has any bearing on my investment process or investment strategy. Given the past track record of a large majority of Indian mutual funds, I do not draw any comfort from the due diligence done by mutual funds as to the quality of any business or credibility of any company (and management).

I do not find any substance in the argument of higher demand from mutual funds leading to sustainable re-rating of a stock. We all have seen in recent past, the high MFs holding into a small cap stock is a two edged sword. In the good times, the stocks run up sharply; and when the tide recedes the losses are also overwhelming (remember 8K Miles, HEG, Graphite, Eveready etc.) Even the best of the fund managers have lost huge money in stocks like JP Associates, HCC, NCC, Jet Airways etc. In the present times also I find many mutual fund schemes holding commodity (including chemicals) stocks where the companies have seen sharp rise in earnings due to temporary commodity price cycle. We shall see a repeat of HEG & Graphite in these stocks in 2021 for sure.

Another thing I am missing is that no one has dared question the validity of the rationale and authority behind the October 2017 and the current circular of SEBI. In my view, the following questions need to be asked to SEBI:

1.    Why AMFI does not have an SRO status? As a signatory to IOSCO charter, it is responsibility of SEBI to promote self regulation in securities market. It is 28years since private mutual funds were allowed in Indian markets. The industry has grown materially in past 10years. Why SEBI is not able to persuade AMFI to become an SRO?

2.    A mutual fund investment is a contract between an investor and AMC. The Key information Memorandum (KIM) is an essential part of this contract. SEBI forcing MFS o change KIM for the investments already made may not be good as per the law of contracts.

3.    Fund management is not one of the various businesses of SEBI. Why it is not left to AMCs? In case SEBI finds that AMCs are indulging in unfair practices or their conduct is prejudicial to the interest of investors or securities' market, it has enough powers to reprimand and punish the respective AMC, including cancellation of its registration.