Impact of New SEBI Rule on Parag Parikh Long Term Equity Fund

How SEBI’s new regulation on Multi-cap funds will impact PPFAS Long Term Equity Fund

Introduction

According to the SEBI new rule, Multi-cap Funds asset allocation rule changed. How SEBI move will impact the Parag Parikh Long Term Equity Fund? Lets decode the revised rules of Multi-cap funds and their implications in this article.

SEBI New Rule Impact on Parag Parikh Long Term Equity Fund

Big Announcement : SEBI Circular on Asset Allocation of Multicap Funds

• In a circular dated September 11, 2020, the market regulator SEBI has modified asset allocation rules for multicap mutual funds.
• According tho the SEBI circular, Multicap Funds will have to keep minimum 25% each in all the categories (Small Cap, Mid Cap and Large Cap).
• Thus, SEBI has directed mutual funds to re-jig portfolios of multicap funds to ensure they are true-to-label.

Re-categorization & Rationalization of Mutual Funds (Oct-2017 Circular)

• Earlier in October 2017, SEBI had issued the guidelines regarding categorization and rationalization of Mutual Fund Schemes.
• What are Multicap Funds?
  • As per definition dated Oct-2017, Multicap funds are the diversified equity mutual funds investing across large cap, mid cap and small cap stocks.
  • And the minimum investment in equity and equity-related instruments was 65% of the total assets. There was no other regulation by SEBI on market cap allocation (across large cap, mid cap and small cap)

SEBI New Rule on Asset Allocation of Multicap Funds (Sept-2020 Circular)

• In order to diversify the underlying investments of Multi Cap Funds across the large, mid and small cap companies and be true to label, SEBI decided to partially modify the scheme characteristics of Multi Cap Funds.
• Investment in equity & equity related instruments : Minimum 75% of total assets in the following manner :
  • Minimum investment in equity & equity related instruments of Large Cap companies – 25% of total assets Mid Cap companies – 25% of total assets Small Cap companies – 25% of total assets
• Note :
  • Large Cap Companies : Top 100 companies according to the market capitalization
  • Mid Cap Companies : 101 to 250
  • Small Cap Companies : 251 onward
• Thus, earlier there were no restrictions in allocating money across Large cap, Mid cap and Small Cap stocks.
• Now, SEBI has directed that – for a multicap fund, there will be minimum 75% exposure in equity with minimum 25% each in Large, Mid and small cap category stocks.
• Mutual Fund houses will have to comply with these new norms by January, 2021.

How SEBI’s New Regulation will impact Parag Parikh Long Term Equity Fund?

Latest Allocation

• As seen , currently the fund has allocated 37% to the large cap stocks, 16% to the mid cap stocks , 13% to the small cap stocks , 20% to the foreign equities and ~7% is kept as cash.
• In order to adhere to the latest regulation by SEBI, the fund will mainly have to decrease their allocation to large cap and foreign equities. Thus, the fund house will have to sell ~12% from large cap stocks and ~6-7% from foreign equities.
• However looking at the investment style of the fund, it looks unlikely that they will undertake such restructuring.
• Before discussing the probable solution that the fund will opt, let us take a look at the equity portfolio of Parag Parikh Long Term Equity Fund.

• We can see that the fund has always maintained ~30 stocks in their portfolio including foreign stocks.
• Thus, the fund already seems to be quite focused on these value stocks. Hence, instead of changing the investment style to fit into the new regulations, it is more likely that the fund will change its category to value fund or focused fund.
• If we take a look at the SEBI’s definition of value/ focused fund, it is evident that the fund easily fits into these categories.

• Taking a look at the fund’s equity portfolio, it has allocation to only 20-22 domestic stocks and remaining to foreign stocks. Thus, it will be more convenient for the fund to migrate to focused category, keeping same allocation.

Impact of SEBI’s New Rule on other Multicap Mutual Funds?

• We discussed with some of the mutual fund industry veterans to get an idea how they will tread the changes in allocation.
• One of the probable changes can be that a new mutual fund category might get launched like FlexiCap Category. Many fund houses have suggested launching of new category to SEBI.
• This category will basically allow the fund manager to have flexible asset allocation across small, mid and large cap companies.
• This seems to be a logical solution because of lack of investment opportunities in mid and small cap companies. This is evident as many small and mid cap mutual funds have currently stopped taking fresh funds from the market.
• Another probable change can be that most of the multicap funds can re-categorize themselves into other categories. For example, Kotak standard multicap fund currently has ~76% allocation to large cap companies, it can add more 4% allocation to large cap stocks and re categorize into Large cap fund.
• Most of the funds will prefer re-categorizing instead of changing their investment styles.

Will the new SEBI rule have impact on ELSS, Value , Focus or any other category of mutual funds?

No, this Rule is not applicable to any other category apart from Multicap.