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A Friday circular by Securities and Exchange Board of India (Sebi) dictating asset allocation framework for multi-cap funds has fired up small stocks. The Nifty Smallcap 100 index soared 5.4% on Monday, and is now just about 6% shy of its pre-covid highs. Valuations, in fact, have soared above pre-covid levels, as many stocks may take a long time to return to the profitability levels seen before covid.
Analysts say that this is a sentiment boost that will lift stocks only in the short run. “It is not a stock classification like the one that happened in January 2018. This time, it’s only about one mutual fund category. The impact will be short-lived. There is a lot of enthusiasm among traders and investors who do small and mid-caps as they would be trying to anticipate moves and get ahead of mutual funds,” said Sahil Kapoor, chief market strategist, Edelweiss Broking Ltd.
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Sebi’s circular mandating multi-cap funds to allocate at least 25% of their portfolios to large- mid- and small-cap each is not expected to see re-allocation in a big way to small-caps. While exposure to small-cap stocks within multi-cap fund category is about 9%, fund houses could use other options available to them, such as restructuring a fund’s mandate or merging it with other large cap funds.
Further, rotating funds to small-cap stocks will have a high impact cost for funds. Most of the small-cap stocks have less liquidity and any buying tends to drive up stock prices in a big way. Analysts also note that it will not be easy for fund houses to fulfil Sebi’s mandate quickly. “At an aggregate level for all BSE-500 stocks that are currently considered ‘small-caps’, it could take 2-3 months of continuous buying for multi-cap schemes to achieve the required re-balancing,” analysts at JM Institutional Equities said in a note.
Sebi issued a clarification on Sunday that fund houses can take up re-organization measures such as reclassifying funds as large-caps and merge them with other existing funds. Analysts expect at least 55% of multi-cap funds to use this route in the next few months. “Hopes of a small/mid-cap rally on the back of any rotation are hence likely to be disappointed,” said BofA Securities in a note to clients.
Besides, mid- and small-cap valuations are stretching. “The profit pool for mid- and small-cap has shrunk, and profits have not kept up with the large caps. It seems to be more like a sentiment boost for the short term, rather than a material difference over a longer period of time,” said Kapoor
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