What Is The New SEBI Rule? How Will It Affect The Mid & Small Cap Stocks?

There is a range of discussions going on in the media related to the new SEBI rule. Some are saying this will cause Nifty crash and will change the investment focus from large caps to mid and small-cap firms. So we thought to take a holistic view on this.

Little Background

Multi-cap mutual funds are there in the industry from a long time, and it’s been a favourite category for some investors, as their funds get diversified among small, mid and FHXEGlarge cap stocks. The only rule for multi-cap funds was, they must invest at least 65% of their Assets under Management (AUM, sounds complicated, it’s just the money they pooled from investors) in equity. But there was no further classification rule like the multi-cap fund must invest at least some % in mid & small cap, some % in large-cap. It was at the discretion of the fund managers. It caused many fund managers following the practice of giving more weightage to large-cap firms and allocating small or sometimes zero weightage to mid as well as small-cap companies.

New Rule says that.

In its new rule, SEBI made it mandatory for multi-cap funds to invest a minimum of 75% (up from 65%) corpus in equity. Rest 25% has to invest in equity or debt or cash, which can be decided by the fund manager.

SEBI also mandated that 75% of the corpus for equity must be divided equally as 25% each for large-cap, mid-cap and small-cap firms. Now fund managers are abided by rules to give more weightage to mid-cap and small-cap companies. SEBI has issued a period till Jan 2021 to make this transition happen.

So, what will happen now?

A sum of up to Rs.33000 crore may move to the mid and small-cap sector from large caps due to the new rule. So, there is an expectation of green rally in the neglected mid and small-cap firms, at the same time, Nifty/Sensex large-cap stocks may come under pressure due to the outflow of funds. But as compared to AUM of all equity mutual funds, Rs.33000 crore of multi-cap funds is not a that significant amount. Also, this transition is not one-shot, and it will happen gradually until Jan 2021. So, we don’t see a sudden drop in Nifty because of this, but definitely, there are good days ahead for small and mid-cap stocks.