The Securities and Exchange Board of India (Sebi) has been worried about the rising froth in the small and mid-cap stocks for quite some time. The latest manifestation of that was the Association of Mutual Funds in India’s (Amfi) note to fund houses a couple of days ago. The note asked fund houses to have a policy that would take proactive measures, including moderating inflows and portfolio rebalancing, besides ensuring protection from first-mover advantage of redeeming members. Sebi’s concerns are justified. The assets under management (AUM) of large-cap funds were Rs 2.96 trillion at the end of December; for mid-cap and small-cap funds, they were Rs 2.82 trillion and Rs 2.34 trillion, respectively. More importantly, in the past year, small and mid-cap schemes saw inflows of Rs 40,000 crore and Rs 20,000 while large-cap funds saw outflows of Rs 2,000 crore. Clearly, riskier schemes are in vogue.
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Even the valuations have risen sharply. The current P/E ratio of the mid-cap index at 32.39x is just marginally lower than the trailing five-year average of 32.80x, while the small-cap index’s P/E ratio is at 28.41x, significantly higher than the five-year average of 19.29x. Investors have been flocking to these schemes for the stellar returns. The mid-cap and small cap index has returned 62% and 65% over the past year. And over five years, the compounded annual growth rate (CAGR) is a healthy 22% and 27%. So, both Sebi and Amfi’s job is cut out. But is Sebi’s suggestion for “proactive measures” the right way to go? By ‘artificially’ reducing inflows or forcing fund managers to keep enough cash by selling their portfolios to meet ‘possible’ redemption, the regulator would be doing the market a great disservice for two reasons.
One, they could trigger a sharp fall in the prices of these stocks if fund managers are forced to sell or starved of cash. Two, the cardinal principle of ‘market should take its own course’ will be broken. What is worse is that investor sentiment will get impacted as they could feel that the market regulator is unhappy with the valuation of these stocks or inflows into these schemes. This may trigger redemptions to ‘book profits’ which may not have happened otherwise. The private sector mutual fund industry has been around for over 30 years now, and investors putting money in their schemes should be allowed to grow up. Hand holding is fine up to a point, especially if they are choosing to buy high risk products.
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Rather, the market regulator needs to provide comfort to investors by sending a clear signal that it is not interfering with market forces, and neither will any fund houses do anything leading to erosion of investor wealth. Apparently, it has currently mandated that fund houses should provide more elaborate data in a single sheet to investors on portfolio concentration, single investor exposure, liquidity position, important ratios, among others. That’s a great move as it can help investors make a well-informed decision. There are reports that suggest that Sebi may give a free hand to fund houses to charge a temporary exit load. If true, it’s going to be a bad decision because investors should not have to bear any additional cost if they choose to book profit or simply raise money from their investments. The mandatory advertisement: “Mutual Funds are subject to market risk. Read all investment related documents carefully…” should not be rendered meaningless.
The Securities and Exchange Board of India (Sebi) has been worried about the rising froth in the small and mid-cap stocks for quite some time. The latest manifestation of that was the Association of Mutual Funds in India’s (Amfi) note to fund houses a couple of days ago. The note asked fund houses to have a policy that would take proactive measures, including moderating inflows and portfolio rebalancing, besides ensuring protection from first-mover advantage of redeeming members. Sebi’s concerns are justified. The assets under management (AUM) of large-cap funds were Rs 2.96 trillion at the end of December; for mid-cap and small-cap funds, they were Rs 2.82 trillion and Rs 2.34 trillion, respectively. More importantly, in the past year, small and mid-cap schemes saw inflows of Rs 40,000 crore and Rs 20,000 while large-cap funds saw outflows of Rs 2,000 crore. Clearly, riskier schemes are in vogue.
Even the valuations have risen sharply. The current P/E ratio of the mid-cap index at 32.39x is just marginally lower than the trailing five-year average of 32.80x, while the small-cap index’s P/E ratio is at 28.41x, significantly higher than the five-year average of 19.29x. Investors have been flocking to these schemes for the stellar returns. The mid-cap and small cap index has returned 62% and 65% over the past year. And over five years, the compounded annual growth rate (CAGR) is a healthy 22% and 27%. So, both Sebi and Amfi’s job is cut out. But is Sebi’s suggestion for “proactive measures” the right way to go? By ‘artificially’ reducing inflows or forcing fund managers to keep enough cash by selling their portfolios to meet ‘possible’ redemption, the regulator would be doing the market a great disservice for two reasons.
One, they could trigger a sharp fall in the prices of these stocks if fund managers are forced to sell or starved of cash. Two, the cardinal principle of ‘market should take its own course’ will be broken. What is worse is that investor sentiment will get impacted as they could feel that the market regulator is unhappy with the valuation of these stocks or inflows into these schemes. This may trigger redemptions to ‘book profits’ which may not have happened otherwise. The private sector mutual fund industry has been around for over 30 years now, and investors putting money in their schemes should be allowed to grow up. Hand holding is fine up to a point, especially if they are choosing to buy high risk products.
Rather, the market regulator needs to provide comfort to investors by sending a clear signal that it is not interfering with market forces, and neither will any fund houses do anything leading to erosion of investor wealth. Apparently, it has currently mandated that fund houses should provide more elaborate data in a single sheet to investors on portfolio concentration, single investor exposure, liquidity position, important ratios, among others. That’s a great move as it can help investors make a well-informed decision. There are reports that suggest that Sebi may give a free hand to fund houses to charge a temporary exit load. If true, it’s going to be a bad decision because investors should not have to bear any additional cost if they choose to book profit or simply raise money from their investments. The mandatory advertisement: “Mutual Funds are subject to market risk. Read all investment related documents carefully…” should not be rendered meaningless.
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Tightrope walk for Sebi: Letting investors know the risks is good enough, protection beyond a point is not possible
8
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04.03.2024
The Securities and Exchange Board of India (Sebi) has been worried about the rising froth in the small and mid-cap stocks for quite some time. The latest manifestation of that was the Association of Mutual Funds in India’s (Amfi) note to fund houses a couple of days ago. The note asked fund houses to have a policy that would take proactive measures, including moderating inflows and portfolio rebalancing, besides ensuring protection from first-mover advantage of redeeming members. Sebi’s concerns are justified. The assets under management (AUM) of large-cap funds were Rs 2.96 trillion at the end of December; for mid-cap and small-cap funds, they were Rs 2.82 trillion and Rs 2.34 trillion, respectively. More importantly, in the past year, small and mid-cap schemes saw inflows of Rs 40,000 crore and Rs 20,000 while large-cap funds saw outflows of Rs 2,000 crore. Clearly, riskier schemes are in vogue.
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Even the valuations have risen sharply. The current P/E ratio of the mid-cap index at 32.39x is just marginally lower than the trailing five-year average of 32.80x, while the small-cap index’s P/E ratio is at 28.41x, significantly higher than the five-year average of 19.29x. Investors have been flocking to these schemes for the stellar returns. The mid-cap and small cap index has returned 62% and 65% over the past year. And over five years, the compounded annual growth rate (CAGR) is a healthy 22% and 27%. So, both Sebi and Amfi’s job is cut out. But is Sebi’s suggestion for “proactive measures” the right way to go? By ‘artificially’ reducing inflows or forcing fund managers to keep enough cash by selling their portfolios to meet ‘possible’ redemption, the regulator would be doing the market a great disservice for two reasons.
One, they could trigger a sharp fall in the prices of........
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