SEBI Asks Mutual Funds To Moderate Inflows Into Small And Mid Cap Schemes

The Securities and Exchange Board of India has asked mutual funds to proactively protect investor interest amid "froth" building up in the broader end of the Indian equity market.

Among the steps suggested, asset management companies and fund managers have been asked to consider moderating flows and rebalancing portfolios, according to an internal letter sent by industry body the Association of Mutual Funds in India to mutual fund trustees. The letter, not publicly available, has been seen by NDTV Profit.

Mutual fund trustees have also been asked to put steps in place to ensure that investors are protected from the impact of the first-mover advantage of redeeming investors.

The market regulator has asked mutual funds to act "in the context of froth building up in the small and mid-cap segments of the market and continuing flows in the small and mid-cap schemes of mutual funds," according to the letter.

Retail investors have been drawn to mutual fund schemes investing in mid- and small-cap funds since the start of 2023, with such schemes giving outsize returns during that period.

Just this financial year till January, actively managed small-cap mutual fund schemes have received inflows of Rs 37,360 crore, and mid-cap schemes have received Rs 19,400 crore, according to data released by AMFI on an ongoing basis.

To be sure, some mutual funds have already taken measures over the last few months in the face of unprecedented inflows into small-cap schemes in particular. Some, like Nippon Mutual Fund, which operates the largest small-cap scheme by assets under management, and Tata Mutual Fund, have stopped lump-sum inflows into their schemes.

On the issue of protecting investors from the impact of redemption pressure, the head of a leading mutual fund, speaking on the condition of anonymity, said, "The idea is to put responsibility on the AMC to treat all investors fairly. The market regulator does not want quality shares to be sold in market to fund redemption and for mutual funds to be left with an illiquid portfolio. This does not mean we put a limit on redemption."

"Largely mid- and small-cap spaces may be seeing stretched valuations," said Kirtan Shah, founder and chief executive officer of Credence Wealth. "There could be a natural rebalancing. Investors who have gone overboard in their allocation to this segment should be wary, but those that have followed prudent asset allocation strategies should not bother too much."

"Investors should identify their asset allocation strategy based on their risk appetite," he said. "That means they should identify how much loss they are comfortable with."