Small-cap stocks set for $5.4 billion India regulatory boost

By Nupur Acharya and Ravil Shirodkar

India’s mid- and small-cap stocks are set to receive a boost after the regulator tweaked rules for multi-cap mutual funds, a move analysts say could push about 400 billion rupees ($5.4 billion) to the broader market.

Multi-cap funds must hold at least 75 per cent of their assets in equities -- up from 65 per cent at present -- with 25 per cent each in large, medium and smaller companies to ensure they stick to their mandate of investing in a wide set of stocks, the Securities & Exchange Board of India said in a circular late Friday.

The ruling that lays out how equity assets are to be spread across segments is aimed at balancing the playing field in a polarized market, where a handful of large companies have helped the main stock indexes erase the bulk of virus-induced losses even with India becoming the new global Covid-19 hotspot. Multi-cap funds hold 74 per cent of their 1.4 trillion rupees of assets in large-cap stocks, according to JM Financial Research.

“Many multi-cap funds have traditionally been run with a large-cap bias, in the range of 60 per cent-75 per cent, with some going even as high as 85 per cent-90 per cent depending on their views on relative valuations between the three segments,” said Kaustubh Belapurkar, director of fund research at the Indian unit of Morningstar Investment Adviser.

India mid-caps may benefit from regulatory reforms
The mid-cap segment may get 130 billion rupees, while 270 billion rupees could flow to smaller companies as managers rebalance portfolios, Belapurkar said. JM Financial estimates the total inflow at 411 billion rupees.

Funds have up to February 2021 to meet the new norms and are unlikely to rejig holdings in a hurry. Some plan to ask Sebi to extend the deadline to reduce the impact cost of portfolio transitions.

“I will not buy small- and mid-cap stocks if it doesn’t make sense for our unitholders,” Nilesh Shah, managing director of Kotak Asset Management Co., whose multi-cap plan is the industry’s biggest with assets of about 300 billion rupees. “We have communicated this to distributors so that people don’t go overboard with speculation on Monday.”

Merge Plans
Kotak Asset will study options including merging the multi-cap plan with a large and mid-cap fund, or convert it to a thematic product like ESG fund, to maintain the portfolio quality and comply with the new rules at the same time. “We may even consider returning money to investors. There’s no rush to do something right away,” said Shah.

Smaller companies -- the stars of India’s market in 2017 -- have trailed the benchmark indexes in the past two years, as investors sought the safety of the biggest stocks amid headwinds from the crisis in the shadow bank sector and the slowdown in economic growth even before the pandemic struck.

The S&P BSE MidCap Index fell for a second straight year in 2019, even as the main S&P BSE Sensex posted its fourth annual advance.

A move by Sebi to standardize classification across funds in 2018 led to most fund flows moving to the top 100 companies. Friday’s order aims to restore the balance, analysts said.

“Whether it can be attributed to Sebi’s earlier categorization or not, mid-cap indexes have slid throughout the two-year period,” said Vidya Bala, head of research and co-founder at Chennai-based Primeinvestor.in. “With small companies under stress for funding, it is possible Sebi sees the need for re-distribution of money in the capital market.”