Context: The Securities and Exchange Board of India (Sebi) has imposed limits on stock market investments of multi-cap schemes of mutual funds.

More about SEBI’s move:

  • Sebi has specified that the minimum investment in equity and equity-related instruments of large, mid, and small cap companies in multi-cap schemes should be 25 per cent each of total assets under management of the scheme. 
    • So, if a multi-cap scheme of a fund house has an AUM of Rs 10,000 crore, it will have to invest at least Rs 2,500 crore each in the three categories of stocks. 
  • The fund manager is free to invest the remaining Rs 2,500 crore in any category they want.
  • Earlier, there was no such minimum investment guideline  for multi-cap funds. 

Stocks are an investment in a company and that company's profits.

  • A company might use money raised from a stock offering to fund new products or product lines, to invest in growth, to expand their operations or to pay off debt.
  • Companies typically begin to issue shares in their stock through a process called an initial public offering, or IPO.

Benefits: Investors buy stock to earn a return on their investment. The return generally comes in two ways:

  1. When the stock’s price goes up, one can then sell the stock for a profit.
  2. Most investors own common stock which comes with voting rights, and may pay investors dividends.

Types: Stocks of companies are of three types

  • The stocks with a market cap of Rs 10,000 crore or more are large cap stocks
  • Company stocks with a market cap between Rs 2 crore and 10 crore are mid cap stocks.
  • Those less than Rs 2 crore market cap are small cap stocks.

The categorisation has been done to ensure uniformity in respect of the investment universe for equity schemes. 

Rationale behind SEBI’s move

  • This is being done to diversify the underlying investments of multi-cap funds across the large-, mid- and small-cap companies.
    • Mutual funds have been focusing on the top 100 large-caps as many of them are good performers and give decent returns to investors.
    • Data shows that in 27 out of the 35 multi-cap schemes, large-cap stocks account for over 60 per cent of the scheme’s investment and in case of 18 schemes, large-cap companies account for more than 70 per cent of the scheme’s investments.
    • Recently the Reserve Bank of India Governor warned that there is a clear disconnect between sharp surge in stock markets and the state of real economy as surplus global liquidity is driving up asset prices across the world.
  • A huge fund flow to big caps had artificially pushed up benchmark indices recently. There is huge liquidity in the financial system which is driving up stock prices.

Implications of the SEBI guidelines:

  • So, in order to meet the minimum 25 percent location to mid and small caps, fund houses will have to move an aggregate investment amounting to Rs 40,000 crore to mid-cap and small-cap companies.
  • This is expected to result in a decline in share prices of some large-cap companies and surge in share prices of mid and small-cap companies. 
  • The move will also result in clearer differentiation between large-cap funds and multi-cap funds as a majority of the muti-cap funds currently have their investments in large-cap companies. 

Why are mutual funds unhappy?

  • Mutual funds were getting decent returns by investing in large-cap stocks, which were leading the Sensex rally in the last two years. 
    • On the other hand, mid and small caps don’t offer the desired comfort level to fund managers.
    • Investors' returns may come down also or the schemes may carry higher risk. 
  • Fund managers also want the Sebi to slap similar curbs on foreign investors (FPIs)
    • FPIs are free to invest in any stocks. 
    • While FPIs have invested Rs 9.33 lakh crore in Indian equities, domestic MFs equity investments amount to Rs 7.69 lakh crore.

As the mid and small-cap stocks rise on account of fresh purchase by mutual funds, the schemes that hold those companies will witness a rise in their NAV going forward. So, investors will see a better return in schemes investing in these companies.

Multi-cap schemes

Sebi has defined 

  • Large cap companies as top 100 listed companies in terms of full market capitalisation. E.g. Reliance, TCS, Infosys, HDFC, HDFC Bank and Hind Unilever. 
  • Midcap companies as the next big 101 to 250 companies in terms of full market capitalisation. 
  • Small cap as companies above 251st in terms of full market capitalisation. 

Market capitalization 

  • It is the aggregate valuation of the company based on its current share price and the total number of outstanding stocks
  • It is calculated by multiplying the current market price of the company's share with the total outstanding shares of the company.
  • Significance: Market capitalization is one of the most important characteristics that helps the investor determine the returns and the risk in the share
    • It also helps the investors choose the stock that can meet their risk and diversification criterion.
  • For instance, a company has 20 million outstanding shares and the current market price of each share is Rs100. Market capitalization of this company will be 200,00,000 x 100=Rs 200 crore.

Mutual Funds

A mutual fund is a pool of money managed by a professional Fund Manager.Simply put, the money pooled in by a large number of investors is what makes up a Mutual Fund.

  • It is a trust that collects money from a number of investors who share a common investment objective and invests the same in equities, bonds, money market instruments and/or other securities. 
  • And the gains generated from this collective investment is distributed proportionately amongst the investors after deduction of applicable expenses and levies, by calculating a scheme’s Net Asset Value or NAV. 

Net Asset Value

  • The NAV is the combined market value of the shares, bonds and securities held by a fund on any particular day. 
  • NAV per Unit represents the market value of all the Units in a mutual fund scheme on a given day, net of all expenses and liabilities plus income accrued, divided by the outstanding number of Units in the scheme.

Source: amfiIndia


Image Source: Economic Times