Intent is to prevent aberration from build up of euphoria to avoid concentration risk
Of late, post Covid-19, investors have limited options to put monies when fixed income yields at rock-bottom making post-tax returns not attractive to hold for long term when headline inflation is beyond RBI’s tolerance zone. It gets worse when there’s limited options on floating rate products. So, retail monies flow into large cap stocks that are considered safe bet, adding to the weight of already heavy appetite from FPIs for large cap stocks. All taken, roughly 75% of investors monies move into large cap companies, the top-100 in market cap! It’s not that appetite gets spread-out evenly, but ends up in chasing the top-quartile, that builds up significant divide between the market cap of top 25 stocks and rest of the listed stocks, spread across mid cap (101-150 top stocks) and small cap (other than top 100 + 150 stocks).
SEBI, as regulator see this as emergence of systemic risk in the event of burst of asset bubble. While wholesale investors will be able to digest big hit given their capacity to absorb or playing with third-party monies, the worst hit is on retail investors, also taking on the risk of failure of fund managers. It’s obvious that when into “waterfall” kind of collapse, exit option gets closed from absence of liquidity on the bid and trigger of lower circuit. Be that as it may, SEBI also don’t see aggregators (Mutual Funds) as shield to dilute systemic risk and defend & prevent harsh impact on retail investors. Needless to say, the top priority and purpose of creation of AMC/MFs was to attract retail investors into primary & secondary debt & equity capital markets to add depth & liquidity to financial markets.
Unfortunately so, multi-cap Mutual Funds haven’t spread their investments across large, medium and small cap companies. It’s largely skewed towards large cap, thus pushing major indices up in disconnect with the performance of real economy. Obviously so, the regulator need to force-in the course correction, hence the restriction of minimum 25% on each category, leaving the flexibility of balance 25% with the fund manager. From regulatory perspective, need to take this as intent to safe guard the interest of passive retail investors and to preserve system’s level playing field to all, cutting the greed of deep pocket & large investors.
Have AMCs living to expectations and for the purpose of creation?
AMCs exist to support retail investors and increase retail participation in India equity & debt capital markets, given that retail investors lack bandwidth on time, skills and volume. It’s felt that with the backing of retail monies, MFs can emerge as shield for the system to minimise the risk from wholesale investors, especially the FPIs. Unfortunately, AMCs got into AUM greed diluting the focus on preserving stability on the NAV.
Why AMC play for the gallery? Is it from the fierce competition for AMUs? Is it from relative better performance on NAV, pull trigger to attract investors? Is open ended option a deterrent for higher emphasis on liquidity? While giving importance to the system and retail investors, regulators need to resolve irritants around some of these questions.
So, the intent is not to blame AMCs in general and Multi-cap funds in particular that they stand in deviation in letter and spirit, being fully aware of limitation on execution. It’s time to get real – either into rebalancing of allocation by selling in large cap counters and buying in mid & small cap counter or stripping of the fund to avoid disruption of the market (that would damage the NAV of their large cap & sectoral funds) and to get into more specific to small & medium cap funds, avoiding large cap companies. AMCs also have to worry about “opportunity loss” that dilute the act of prudence from fear of underperformance with benchmark indices.
What’s the impact? Is it enough from SEBI?
SEBI’s follow-on clarification to the order has restored normalcy, and set to achieve the valuation objective sooner than later. There’s again 2 opinions on this matter. When (excess) liquidity is chasing safe-haven stocks, what could be done to close the liquidity gates? Is there need to do away with the index, which glaringly reflect the distortion with the real economy. In all probability, this restriction can help around 25 companies in each category (max around 100 in number)? Will there be intra-category restrictions? So, in the big picture, this stricture is not to be seen as systemic benefit, and kind of “stick on the knuckles” for the fund managers to act as per mandate.
What’s the feel of retail investors, the worst impacted stakeholder? Most times, these passive investors are taken for serious ride and RBI coming to their rescue extending liquidity support to erring Mutual Funds. Is SEBI doing enough on investors literacy? Can systemic stability on capital markets be achieved when large numbers of listed companies not exhibiting transparency on disclosures, understated earnings, below-par standards on compliance & governance and absence of regulatory shield for the passive & innocent stakeholder, the retail investor? Need elaborate discussion on these rather than doing piecemeal actions for the record.
What’s bottom-line and take-away for the way forward?
Bottom-line is that issues are many while the resolutions are few lacking precision. Equity markets most often get into disarray by FPIs, either flooding the market with leveraged liquidity (accessing cheap monies from developed economies) or seek one-shot exit when going gets tough on domestic market place or external liquidity tap gets closed or become costly, cutting carry-trade advantage. Obviously so, FPIs are categorised as “fair weather friends” and major contributors to “hot money component” of India foreign currency reserves. So, it’s like riding the tiger, can’t get off from FPI’s back or keep riding for perpetuity. If resolution is achieved here, it’s kind of half-way through situation and makes the rest of the journey smooth. Leaving this as thought, as this itself is major topic for discussion which I shall handle separately.
Are AMCs emerging as good alternate to FPIs? Most often, they get caught between FPIs and markets while enjoying the best times and unable to handle the worst, sending SOS calls to RBI for liquidity support to face redemption pressures. They are also seen as fallback for cash rich domestic wholesale entities including Banks, parking excess cash in so-called liquid funds, pushing MFs into round-tripping (investing on CPs/CDs/NCDs) taking huge ALM risk exposure. So, there is enormous clean-up needed in utility of AMCs for the system – keep this for discussion for another day.
So, all combined, nothing spectacular to emerge for the system, either to increase attention & appetite beyond 100-odd listed companies nor provide better comfort to retail investors nor set AMCs in order. Need lots to do to make India financial markets a better market place!
Just thinking aloud….happy reading,
Yours Truly….Moses Harding
