The largest private bank, HDFC Bank has announced its merger with the housing finance behemoth – Housing Finance Development Corporation (HDFC) on 4th April 2022. This is likely to benefit HDFC Bank in the long run. However, the merger of HDFC Bank and HDFC may cause a sell-off in a few mutual funds. Now, why would mutual funds sell? This is because mutual funds have a capping of 10% for investment in a single stock, as prescribed by SEBI which means mutual funds cannot have more than 10% allocation in a particular stock. Index Funds, ETFs and sectoral funds are an exception to this rule.
HDFC Bank and HDFC are among the fund managers’ favourites. As of Feb 2022, 483 mutual fund schemes held shares of HDFC Bank worth Rs.1.02 lakh crores, accounting for 5.35% of overall equity assets of the mutual fund industry while 340 schemes held shares of HDFC worth Rs.45,473 crores, accounting for 2.38% of the overall equity assets of the mutual fund industry, as per ACE MF data. Overall, mutual funds have a combined investment of Rs.1.47 lakh crores in HDFC Bank and HDFC. Now let us have a look at the mutual fund schemes having a combined weightage of more than 10% in HDFC twins.
About 40 mutual funds have more than 10 percent allocation in HDFC Bank and HDFC. Since no scheme can have more than 10% exposure in a particular stock, fund managers may have to revisit their portfolios to adhere to the capping norms.
The capping rule may also result in underperformance by actively managed mutual fund schemes compared to the benchmark and passive funds. As of Mar 2022, HDFC Bank and HDFC have a weightage of 8.43% and 5.66% respectively in the Nifty 50 Index. So, the Nifty 50 index has a combined weightage of 14.09% and a similar weightage is expected post-merger in the merged entity.
If a stock with more than 10 percent weightage in the index outperforms, active fund managers may find it difficult to beat the benchmark as they have a cap of 10 percent. Something like this happened in 2020 when the weightage of Reliance Industries in Nifty 50 rose to a record high of 14%. Now, if HDFC Bank outperforms other constituents in the index, active funds will underperform due to less than 10% exposure to the company. The converse is also true. If the company having more than 10% weightage in the index underperforms, funds having a lower allocation to the company than the index will perform better. Will the merged HDFC Bank outperform? Well, it depends on the fundamentals of the company and the factors affecting the stock market. Overall, the merger is expected to have strong growth opportunities ahead due to economies of scale and cost synergies.
The merger is expected to be completed in the next 15-18 months. Once the merger is completed, mutual fund schemes containing these stocks may see some changes. There will be no impact on passive funds as they simply mimic the index but for active fund managers, it will be a challenge going forward as they will have to trim the position and rebalance their portfolio. Active fund managers will only act when there is sufficient clarity and regulatory approvals.