Fund inflows restricted due to surging valuations, caution advised

Smallcap and midcap funds see surge in retail investments

Mutual funds

ICICI Prudential Mutual Fund, the country's second largest fund house, has announced curbs on investments in its smallcap and midcap funds. It joins a few other asset management companies that have restricted inflows into such schemes that predominantly invest in small and midcap stocks amid soaring valuations and even the market regulator SEBI warning of building up of froth. 

An investor will not be able to make any fresh or additional lumpsum investments in ICICI Prudential midcap fund or smallcap fund. Investors will also not be able to switch money into these funds from other funds of the AMC. The fund house will continue to allow fresh registrations through SIP (systematic investment plan) or STP (systematic transfer plan), but there will be a limit of Rs 2 lakh per PAN per month per scheme.

"Keeping the interest of the investors protected from sudden market movements, the trustees have decided to temporarily discontinue subscriptions in the schemes," ICICI Prudential MF said.  

Kotak Mutual Fund too had recently restricted flows into its small cap fund. Beginning March 4, it capped SIP and STP in Kotal smallcap fund at Rs 25,000 per pan, per month and lumpsum investments have been capped at Rs 2 lakh.

"Few stocks in the small and midcap segment have multiplied, and strong momentum is taking them beyond the fair value of businesses," it had pointed.

Retail investments into mutual funds have soared over the last few years. Buoyed by the strong returns over the past year, smallcap and midcap funds, in particular, have seen large flows. In February 2024, midcap funds saw net inflows of Rs 1,808 crore, while smallcap funds saw Rs 2,922 crore inflows, and largecap funds received Rs 921 crore, according to data from Association of Mutual Funds of India (AMFI).

The net assets under management of midcap and smallcap funds as of February 29, 2024 stood at Rs 2.96 lakh crore and Rs 2.49 lakh crore respectively. The AUM of midcap funds is not too far behind the large cap funds AUM of Rs 3.06 lakh crore now. 

The Securities and Exchange of Board of India has been voicing concern over the surge in small and midcap investments. AMFI last week wrote a letter to mutual fund houses urging them to take steps and put in safeguards to protect the interest of investors in smallcap and midcap schemes.

The BSE Midcap index has jumped more than 62 per cent in the past one year. Similarly, the smallcap index too has risen more than 56 per cent. In contrast, the BSE Sensex is up 26.5 per cent. 

On Wednesday, the BSE Smallcap index was down 4 per cent in afternoon trading and the midcap index also fell over 3 per cent. The BSE Sensex was down 0.9 per cent.

"Momentum chasing by investors, coupled with limited free float available in the market, has created valuation distortions in a few cases. Such experience is further boosting investors' confidence, over-shadowing the caution required," Kotak Mutual Fund had noted in its statement.

Gaurang Shah, senior vice-president, Geojit Financial Services agrees.

"Excessive liquidity drove up midcap and smallcap stock prices, often exceeding their justified values based on earnings. The surge in funds flowing into these segments compelled fund managers to invest, further inflating valuations," he pointed.

Given the historical volatility of small and midcap stocks, its crucial for investors to exercise caution in allocating funds, whether directly in stocks or through mutual fund SIPs, said Shah. 

A recent survey of fund managers by Centrum Wealth too had pointed to valuation concerns building up.

"Almost all participants are clear that their portfolios are not cheap vis-a-vis history. An equal proportion feels that their portfolios are either fair or overvalued versus the past," it said.

Most fund managers had ranked mega caps and large caps to be relatively attractive, followed by mid, small and microcaps. 

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