IDFC Mutual Fund is the latest fund house to join the ranks of those which have restricted heavy lump-sum investments in their funds. It has limited lump-sum investment in IDFC Focused Equity Fund to Rs 2 lakh a day. Similar restrictions have been imposed in the recent past in other funds: DSP BlackRock Micro Cap, Edelweiss Tax Advantage, L&T Emerging Businesses, and SBI Small and Midcap Fund. Investors should heed the message in these measures being taken by fund houses and avoid lump-sum investments at a time when valuations are high.
Some fund houses are imposing restrictions because they fear rapid inflows could cause style drift, that is, the fund could be forced to deviate from its mandate. Take the case of IDFC Focused Equity. In April, its assets under management (AUM) stood at Rs 117 crore and currently it has crossed Rs 900 crore. It is now a multi-cap fund with a focused strategy, which holds 30 stocks across market caps. Also, it follows a nimble strategy. The fund manager books profits and moves out of stocks where his profit goals have been realised. To stay nimble, he needs to stick to liquid stocks. Now, with a 17 per cent allocation to small-cap stocks, an inflow of, say, Rs 500 crore means an additional investment of Rs 85 crore in small-caps, many of which have small free-float. Investing heavily in them can lead to high impact cost. Investing in new names is not an option for a concentrated fund. Many funds move into mid- and large-cap stocks to avoid the impact cost, which leads to style drift (it’s no longer a multi-cap). “To stay true to the mandate of a focused fund with a nimble strategy, we took this step to moderate inflows. While it remains open for retail investors, the fund manager now gets more time to deploy the fresh money that comes in,” says Vishal Kapoor, chief executive officer, IDFC Mutual Fund.
Most other funds mentioned above are in the mid- and small-cap space, where valuations have skyrocketed. The Nifty Midcap Index is trading at a trailing price-to-earnings (P/E) ratio of 46.4, twice its five-year average of 23.4, and the Nifty Smallcap at 178.4, thrice its five-year average of 57.7. “Fund managers are not finding enough attractive opportunities at attractive valuations in these strategies, so they feel that it would be prudent to restrict investments,” says Kunal Bajaj, founder and chief executive officer (CEO), Clearfunds.com.
Mid- and small-cap funds have delivered an average annual return of 23 per cent over the past five years. “Seeing such high past returns, speculators are entering them. Such hot money comes in fast but also goes out fast — at the first sign of a market reversal. The fund manager has to liquidate holdings to meet redemption pressure, which hits performance. Fund houses are keen to avoid this, and are hence trying to moderate inflows,” says Prateek Mehta, co-founder and CEO, Upwardly.in, a Bengaluru-based wealth advisory and investment platform.
The expense ratio (fee) that fund houses charge is a percentage of their AUM. A fund house restricting flows is a positive sign. “It indicates that the fund house has chosen to protect investors’ interests over gathering additional assets,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India.
Whenever it is announced that a fund is going to restrict investments, some investors think they will miss out on a great opportunity and rush in to purchase aggressively in that fund. Avoid doing so.
Heed the signal coming from fund houses and avoid lump-sum investments. At the same time, keep systematic investment plans (SIPs) going. Invest large amounts via a systematic transfer plan (STP). Finally, stick to your equity-debt allocation. Don’t increase allocation aggressively either to equities, or to the mid- and small-cap segment.