Mid-Cap, Small-Cap Shares Recover Marginally After Yesterday's Dip: Reasons For Dip And AMFI's Advise

Mid and small-cap shares faced a significant downturn on February 28, with respective indices plummeting by around two per cent. The S&P small-cap index continued its decline into the next day but is showing a slight recovery from 11 am. Nifty Midcap 50 tumbled from 13,914 points to 13,590 yesterday, and today bounced back to 13,696 points as of 1 pm February 29, 2024. A major contributing factor to the market's total downturn is attributed to the substantial selling of Indian stocks by Foreign Institutional Investors (FIIs). However, the most important reason is said to be an advisory from the Association of Mutual Funds in India (AMFI) to its member asset management companies, at the behest of the Securities and Exchange Board of India (SEBI).

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What Did AMFI Say?

Concerned about huge recent inflows into small cap& mid cap funds, the AMFI sent a letter on February 27 to MF trustees asking them to protect investors' interests by implementing policies like moderating inflows into small and midcap schemes and rebalancing portfolios.

"In the context of the froth building up in the small and midcap segments of the market and the continuing flows in the small and midcap schemes of mutual funds, Trustees, in consultation with Unitholder Protection Committees of the AMCs, shall ensure that a policy is put in place to protect the interest of all investors," the AMFI letter dated February 27 said.

Apart from advice such as moderating inflows into small and midcap schemes, and rebalancing portfolios, Sebi asked Trustees to ensure that investors are protected from the first mover advantage of redeeming members. The policy of mutual funds has to be approved by Trustees and disclosed on each AMC's website within 21 days.

A Reuters report mentioned anonymous AMFI members saying mutual funds may have to halt redemptions during sudden outflows or enhance portfolio liquidity by raising cash reserves or investing more in large-cap stocks. These funds are mandated to allocate at least 65 per cent of assets to small-cap stocks or mid-cap funds to be categorized as small-cap funds and mid caps respectively, with the remaining 35 percent in cash or large-cap stocks.

Why AMFI Made This Move?

The S&P BSE SmallCap index has surged by over 60 per cent in one year, compared to the broader BSE Sensex, which saw around 18 per cent increase. This surge in returns led to concerns about the overvaluation of small-cap stocks and potential correction ahead. One minimal correction was seen in September 2023.

The surge in returns was such that small-cap mutual funds saw inflows of Rs 41,035 crore in 2023, double the previous year's inflow. Some small-cap funds have given 60 per cent to 70 per cent returns in the last year. This exacerbates overvaluation risk causing a correction.

Sebi's directive in January had already prompted small-cap mutual funds to conduct stress tests to assess their resilience against sudden outflows when there is a market decline.

Ahead of the AMFI proposed measures, Kotak Mahindra Asset Management Company Limited had already imposed restrictions such as capping the investment amount to Rs 2 lakh per PAN (first holder or guardian) per month for any lump sum investments, in small-cap funds. Similar measures were earlier taken by other AMCs like SBI MF, Nippon India Life Asset Management, and Tata Mutual Fund.