Small caps rise after Sebi changes MF multicap standards, but rally may not last long

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Sebi’s recent circular fine-tuned the asset allocation framework for multicap mutual funds has caused small stocks to explode. The Nifty Small-Cap 100 Index climbed 5.2% on Monday, about 8% below its pre-covid highs. Analysts believe this is a boost in confidence that will push stocks up in the near term. But as valuations have climbed above pre-covid levels and many stocks could take time to recover from the profitability of the pandemic.

Indeed, Sebi’s circular requiring multi-cap funds to allocate at least 25% of their portfolios in large, medium and small caps each could see a certain drop in their funds. Almost 74% of almost 1.4 trillion invested in multi-cap funds is invested in large caps, making them near-large cap funds. While SEBI clarified that fund houses have certain options to reassess the mandate of these funds, markets have already started to inflate small-cap stocks.

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“This is not a stock classification like the one that occurred in January 2018. This time it’s just one category of mutual fund. The impact will be short-lived. There is a lot of enthusiasm among traders and investors doing small and mid caps today as they would try to anticipate moves and get ahead of mutual funds. It will last a few days, ”said Sahil Kapoor, Market Strategist, Edelweiss Securities Ltd.

Best multi-capitalization funds with 1 trillion assets under management have lower single-digit exposure to small-cap stocks. Note that turning a portfolio of this size into small and mid-cap stocks is not easy. First, small and mid-cap stocks have low liquidity and therefore implementing these measures will have a high impact cost for fund houses.

Also, it will take a long time to meet the requirements given the low market capitalization. “At an aggregate level for all BSE-500 stocks that are currently considered ‘small caps’, it might take 2-3 months of continuous buying for multi-cap systems to achieve the required rebalancing. This assumes that MFs buy all of the 250 small caps from the BSE-500 and that MFs are able to get 30% of the delivery volumes of those stocks each day, ”analysts at JM Institutional Equities said in a statement. customer note.

In reality, fund houses are more likely to approach SEBI for their system reorganization given the low liquidity of small cap stocks. SEBI released a clarification on Sunday saying fund houses may take reorganization steps such as reclassifying funds as large caps and merging with other existing funds. Analysts predict that at least 55% of multi-cap funds will use this route in the coming months.

In addition, the valuations of mid and small caps are stretching. The impact and disruption of the pandemic on small and mid-cap companies has been significant, especially in the case of manufacturing. Valuations of the CNX Nifty Small-cap 100 index have already crossed its pre-covid highs with a price-earnings multiple at 33 times earnings. In February, the PE stood at 27 times current profits, according to National Stock Exchange data.

“The profit pool of mid and small caps has shrunk and earnings have not kept pace with large caps. It looks more like an upsurge in sentiment in the short term than a material difference over a longer period of time, ”Kapoor said.

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