The path breaking move by Sebi could lead to a big churn in the markets. While it could lead to a re-rating in small and midcaps, it could fix the underperformance challenge in the mutual fund industry so far. What is your view?
If you see the dynamics of the Indian economy, we are a country with a lot of entrepreneurs and a lot of entrepreneurship driving economic growth. There was this move a few years back when mutual funds were discouraged from investing in mid and small caps and that created a very lopsided market with a few larger companies trading at PE multiples of 60-70-80 and the rest of the market just being ignored.
One thing which we have to realise is that what Sebi has done is a great progressive step. The name of the funds are multi-cap and by nature multi-caps should invest all across the market cap. However, for whatever reasons, the investments were being concentrated in only a few stocks. The latest Sebi move will broadbase the investment horizon leading to even the smaller and midcap companies getting access to capital.
Investors again are starting to take interest in them and for a country like India, a broad-based market helps the economy. So I think it is a great move. In terms of what it will do, there is definitely going to be rebalancing, however, there is time. We have three-four months before this whole thing is completely applicable. Funds will have time to rebalance their portfolios. Whatever they do, I do not know whether it will add to the performance or not though ideally it should. But it will ensure that multi-cap funds stick to their true true nature which is investing across the market caps.
If the multi-caps were generally not multi-caps and had higher allocation towards large caps, does not the corollary mean that the real appetite is also for the large caps? What is it going to mean for the large cap funds versus the small and midcap funds?
Market moves in bouts of risk taking and risk averseness. Last two-three years saw a bout of risk averseness and that made fund managers and investors a little bit more wary about equity investing and led them to being a little bit defensive and going into the regular or the so-called comfort stocks.
What will happen now is that obviously the economy is looking at coming out of the Covid situation and second is because of this regulation, you will have to go a little bit broader. The valuation gap where some companies in the large cap side are trading at 60-70 PE multiples and some on the mid and small cap trading at like 10 and 12 PE multiples or even lower,
That valuation gap will narrow now. As a pre-empt to that, there is a possibility that more flows will also start to come into the broader markets which are mid and small caps rather than only going into a narrow section of the market. All in all, we will see some adjustment over the next two-three-four months but very clearly the interest to some extent is going to shift away from the very high PE stocks to a broader market dominated by the midcaps.
Many believe that this will lead to a big bull run in the midcaps and the smallcaps? How will this bull run be different from what we have seen in the past? Would corporate governance and business models define which are the stocks that will move up?
Management, corporate governance and fundamental aspects are the predominant characteristic which any good fund manager will look at before investing whether the stock is a midcap or a smallcap or a large cap. There is no doubt that those are the characteristics which are needed when we do fundamental analysis.
The only difference is that the gap in multiples because of flows and non-fundamental reasons which we are seeing over the last few years, will get corrected to some extent.
Whenever you do a fundamental analysis, all the trades which you mentioned have to be the pre-eminent trades to look at before investing. I would say there has to be some gap between the largecap and midcap and smallcap but those gaps cannot be 10 PE to 80 PE. That gap will narrow down.