Does it make sense to enhance the definition of stocks for mutual funds
There has been growing demand from the mutual fund houses to enhance the definition of the stocks that should be classified as large-cap, mid-cap and small-cap stock for mutual fund investment. In October 2017, commodity and capital market regulator has come out with a circular that introduced rationalisation and categorisation of the mutual fund schemes. To ensure uniformity, SEBI issued a list defining large-cap, mid-cap and small-cap companies. Earlier, each fund house would employ its own criteria for deciding the classification of stocks into a different cap. This made the comparison of funds difficult. Hence, according to the circular, top 100 companies were categorised as large-cap, next 150 as mid-cap and beyond that, it was small-cap stocks.
Besides this, the circular also set the limit of investment by different categories of funds in stocks of the category. For example, a large-cap fund is required to maintain 80 per cent of its portfolio in large-cap stocks, while a mid-cap and the small-cap fund would have to maintain a minimum of 65 per cent of its portfolio in these stocks.
This change led to rejig of portfolios of the mutual funds and coincidently broader market too saw fall in the same period. Many attributed this fall to the change introduced by SEBI.
Nevertheless, detail analysis of the portfolios of the mutual funds for the categories is not even using the current allowable limits to diversify their holdings. For example, mid-cap categories of the fund that can invest upto 35 per cent of their corpus beyond 250 have invested only 12%. Similarly, large-cap funds that can invest upto 20 per cent of their corpus into companies beyond 100 have invested only 5%. This shows there is not much merit in expanding the list.
Returns in the mutual fund are generated in cycles and are not smooth. As we saw the year 2017 generated return in excess of 30 per cent for many funds, which led to higher valuation and what follows is a reversion to mean. Hence, we do not see expanding the definition of market caps will make much of sense in generating a better return for investors