Mutual Funds Emphasize Fair Treatment for All Investors Amid Small and Mid Cap Heat

The Securities and Exchange Board of India (SEBI) is raising red flags around the surging valuations in small-cap markets, pushing mutual funds to prioritize investor protection measures. SEBI's concern stems from the potential impact on investors due to an uneven playing field caused by the 'first-mover advantage' in redemptions, which could unfairly benefit some at the expense of others.

Understanding the 'First-Mover Advantage'

The first-mover advantage refers to the benefit that early redeeming investors might receive by cashing out at a higher Net Asset Value (NAV), while those who redeem later could face a lower NAV. SEBI's objective is to curb scenarios where this advantage takes place.

Preventative Measures for Investor Equity

Industry leaders have conveyed that the measures are intended to establish a preemptive framework to avoid any disparity among investors. This includes asset management companies considering the control of investment inflows and the rebalancing of their portfolios to manage risks efficiently.

Fund managers are urged to treat every investor with equality and avoid making hasty sales of quality shares in the market to generate funds for redemptions, which could result in an illiquid portfolio. It's crucial not to cap redemptions but to maintain a fair system for all parties involved.

Influx in Small and Mid Cap Fund Investments

HDFC Midcap Opportunities and Nippon Smallcap Fund have seen significant inflows, ranking them among the top five funds by assets under management with AUM upward of ₹40,000 crore and ₹30,000 crore, respectively, as of December 2023. These investments come with a caveat; for instance, Nippon Mutual Fund halted lump-sum inflows into its small-cap schemes last year due to the overwhelming volume of inflows.

One approach suggested by fund managers to mitigate first-mover disbalances is to maintain liquidity by keeping part of the portfolio in larger-cap names. While this strategy is within the valuation guidelines set by SEBI, it may not always be sufficient, especially if large redemptions are requested simultaneously.

Guidelines and Practices for Sustaining Stability

Small-cap funds are mandated to allocate at least 65% of their holdings in their category, with many large asset management companies typically investing around 70–75%. To ensure investor exits are manageable, funds may keep a portion in larger-cap stocks. However, this is not without its challenges; selling small or mid-cap stocks is sometimes unavoidable during redemptions.

The ongoing discussions and measures indicate a concerted effort by the industry and regulators to shield investors from potential risks and provide an equitable investment landscape.

Investment, Protection, Equity