Small and midcap funds: Sebi steps in. When will you?

Amfi, in response, directed the fund houses:

"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 letter read.

So far so good. It was brave of Amfi to lift the “froth" line verbatim in its missive to the mutual funds. Given it’s an industry body, many members of which are still pushing investors to put money in “frothy" funds.

Anyway, there’s much to take away from this entire episode. And in this edition of Contramoney, we will do just that.

First, let’s start with Sebi. There’s no doubt that Sebi’s directive is a solid step that will perhaps make an impact. I say perhaps because the regulator cannot really tell you and me what to do with our monies. It has done what it can do – instruct the industry to act. Now it remains to be seen how they go about doing this.

While I do not want to nitpick, my question is this – why so late? Many, including this column, have warned about the flood of money into small and midcap funds (and more recently how it’s being diverted to thematic funds). Too much money chasing such stocks has naturally led to more froth. On top of that, the funds are now too large, and whether they can give fair exits in case there was a rush to get out, is questionable. Some funds will counter this (probably due to this regulatory action) by increasing allocation to the more liquid large-cap stocks perhaps, or then hold more cash. Either way, the damage is kind of done. And to undo, we will need to make these funds behave more like Flexicaps!

We need Sebi to do a lot more. Here is my full list of recommendations for the regulator.

Second, let’s take a look at the role played by AMFI, and its members i.e. the mutual funds. Before discussing this, it must be said that some fund managers saw these issues coming a mile away. Kudos to them. Still others (I know of only one), refused to launch a dedicated scheme for small and midcaps. Even better!

This same industry which has given us these thoughtful fund houses, has also given us all kinds of sectoral and thematic funds. This is not bad per se. After all individual investors are free to decide how to go about investing.

But launching new schemes in a “frothy" market? And if you think this is a one-off, listen to this. Now that the money flows of investors have moved to thematic funds, guess which schemes the industry is focused on launching? Yep, thematic funds!

While two instances do not a pattern make, dig a little more and the pattern does emerge. For an industry that prides itself on managing ₹50 trillion, perhaps a little more maturity is warranted. If not more responsibility. Is even that too much to expect?

This brings me to the third aspect, which is you. And my question to you is – Why?

Why depend on the regulator to step in to protect your wealth?

Why get drawn into every new idea that hits the market?

Why blindly follow all the advice you get without determining whether or not it's in your best interest?

I can go on and on. Remember, it's your money, and hence, your responsibility.

Sebi, even though belatedly, has stepped up.

Amfi has reacted to the SEBI directive.

Now, the question is what are you going to do to ensure you are not done with the “froth" in the markets?

Here’s some general thoughts on this:

First, review all your investments. If you are over allocated to small and midcap funds, well, take corrective action. Remember, even flexicaps often have exposure to small caps and midcaps. So, when you opt for flexicaps instead, you are not totally walking away from an opportunity.

Second, review all your SIPs too. See where your money is going incrementally. Is it in line with your planned allocation? Is it still feeding into the frothy market? If yes, you know what to do. (Read this earlier edition of Contramoney for more - Sensex at 70K. Is it time to stop your SIPs? Perhaps).

Third, this may be a great time to put in place a solid allocation plan. In a rising market, this feels unnecessary. But when the proverbial tide starts to run out, it is this very plan that will provide you with the safety net. Just think back to what has happened to portfolios in the past which were excessively exposed to tech stocks (in 2000), or realty stocks (in 2007). This should give you additional motivation to act now!

In conclusion, it may help to remember that in the long term not losing money is equally, if not more important than earning it. This should rightfully remind you of the famous Buffett rule. Buffett is sitting on over $160 billion waiting for a great deal. Perhaps, its time for us too to build up some liquidity in the hope of better deals down the line.

Happy re-allocating!

Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477.

You should always consult your personal investment advisor/wealth manager before making any decisions.