The tweaks in the multi-cap fund rules can lead to about Rs 25,000 crore flowing into smallcaps, experts say but they advise caution in stock selection.The new Sebi norms to make multi-cap funds true to label will trigger a rally in select smallcap stocks, market experts have said.

The Securities and Exchange Board of India (Sebi) on September 11 tweaked its October 2017 circular, mandating multi-cap funds to invest at least 25 percent each in smallcaps, midcaps and largecap stocks, leaving the remaining 25 percent to their discretion.

On September 13, the regulator issued a clarification , reemphasising that mutual funds should be true to label and stick to appropriate benchmarking, indicating its seriousness to implement the circular strictly.

“This circular has as big an impact as the introduction of LTCG,” said Purvesh Shelatkar, head of institutional broking at Monarch Networth Stockbroking Ltd, referring to the tax on long-term capital gains. “The Sebi circular will ensure funds are no more required to buy expensive stocks at expensive valuations compulsorily but can diversify into quality small and midcaps.’’

“This circular has as big an impact as the introduction of LTCG,” said Purvesh Shelatkar, head of institutional broking at Monarch Networth Stockbroking Ltd, referring to the tax on long-term capital gains. “The Sebi circular will ensure funds are no more required to buy expensive stocks at expensive valuations compulsorily but can diversify into quality small and midcaps.’’

The shift in multi-cap funds can lead to about Rs 25,000 crore flowing into smallcaps and about Rs 10,000 crores into midcaps, said Abhimanyu Sofat, head of research at IIFL Securities Ltd. “There will be select firms in these categories getting the maximum allocation due to the rule change.’’

The biggest beneficiary will be some smallcaps that haven’t participated in the rally since April. Select mid and smallcaps like MCX, KPIT Technologies, Century Plyboards, Subros, Ramkrishna Forgings, IOL Chemicals, Aarti Drugs, Dixon Technologies, McLeod Russel and CG Power have already rallied and are said to have been cornered by operators, Kishor Ostwal, managing director at CNI Research, said.

The Sebi classifies companies on the basis of market capitalisation. Top 100 companies are largecaps, the next 150 are midcaps and from 251th on are smallcaps.

 AK Prabhakar, head of research at IDBI Securities, sees a massive rally ahead for smallcaps. The public float is so less in some companies that even if strong hands corner 5 percent in anticipation of mutual-fund buying, it can lead to a massive rally, he said. So investors should remain cautious in such stocks, he said.

The Sebi’s decision is not only good for these stocks but also for the economy. Equity inflows of Rs 100 crore in 330 stocks will help these companies raise additional debt of Rs 100 crore at least, which will help them get additional Rs 200 crore worth of business, Monarch’s Shelatkar said.

The tweaking of norms will see an outflow of around Rs 33,000 crore from overvalued largecaps to mid and smallcaps, he said.

“It's easier to outperform with quality small and mid-caps which can offer higher growth opportunities, Shelatkar said.

Market participants have long complained about the lopsided nature of the market rally. Of Rs 7.5 lakh crore of the industry’s assets under management, top 10 companies account for almost half of the assets.

The new norms will help funds diversify their portfolio from heavy concentration of largecaps to select smallcaps, Sorbh Gupta, fund manager at Quantum Asset Management, said.

Investors can look at certain smallcaps still trading at huge discounts. CNI’s Ostwal is willing to bet on Dish TV, Jammu & Kashmir Bank, Bank of Maharashtra, Camlin Fine, Bajaj Consumers, CESC Ventures, NCC, Sudarshan Chemical and Raymond, etc.

To be sure, mutual funds have four months to implement the norms and a lot can happen between then and now, experts said.

Investors should be dissuaded from buying stocks just because of the circular, Nithin Kamath, founder of online brokerage firm Zerodha said.

Some argue that the circular may lead to a lot of shuffling and churn in portfolios. As the business restarts, there could be outflows for a third month from mutual funds, which can be accentuated by job losses in coming months, IDBI’s Prabhakar said. The liquidity factor will play a big role in determining the sustenance of any rally, he added.