Cloud over mutual funds’ narrow mid-cap universe

Mutual fund (MF) allocations to the midcap segment may be under a question mark given that the space has only 150 companies to invest in, and a good part of the publicly available shares are already in the hands of domestic funds.

MFs’ midcap holdings account for 18 per cent of the free float of the companies concerned, shows a Business Standard analysis of the data from fund tracker Value Research and the market data from corporate tracker Capitaline.

This gains significance in the light of the fact that the figure was in single digits for both the largecap and smallcap holdings, leaving far more room for investments in funds focusing on the two categories.

While this does not necessarily ring alarm bells immediately, the universe bears watching and may require changes in regulatory definitions as markets grow, say experts.

An expert said the narrowness of the universe led to ballooning valuations because all the money was chasing a limited number of companies. This, in turn, contributes to midcap schemes outperforming as long as the liquidity keeps flowing.

“Once the liquidity reduces, which is happening, outperformance will also shrink,” the expert said. Dhirendra Kumar, chief executive officer of fund tracker Value Research, says one might need to look at revaluating the classification of midcap stocks in the future so that it is not a rigid number, which limits the fund manager’s choice.

The Securities and

■ Segment lacks liquidity of largecaps

■ Not as many stocks to invest in as in smallcap universe

■ Definition of midcaps may need changes in future, say experts

Exchange Board of India (Sebi) allows midcap schemes to invest over a third of their assets in the securities of nonmidcap companies, according to the regulator’s October 2017 circular. A fund manager who handles midcap schemes too agreed that the universe was narrowly defined. He added the leeway to invest up to 35 per cent outside the midcap universe provided some degree of flexibility for now.

The Sebi circular also said a list of companies which fell in the largecap, midcap and smallcap universe should be prepared on a periodic basis. The top 100 stocks in terms of value are considered largecap, the next 150 are midcap, and the remainders are all smallcap. The largecap universe thus has the most liquid stocks with the highest amount of shares by value accessible to the public. The smallcap segment has thousands of listed companies, though small, to choose from. Midcaps are sandwiched between the two, with a narrow list of 150 companies with neither the liquidity of the largecaps nor the number of stocks available to the smallcap universe.

While the list of stocks that are classified this way is available only in recent times, Business Standard prepared a back-dated list based on quarter-ending market capitalisation, which gives an idea of broad trends since 2013. Not all companies have disclosed the shareholding data for the September quarter this year. So free float was calculated based on the June numbers, with corresponding figures used for MF assets.

The midcap space has had the least headroom, and it has only shrunk in the days leading up to June 2018. Mutual fund holdings in smallcap and largecap stocks are still in single digits, though they have moved up since 2013.