M&M Fin, Federal Bank: Top financial picks post Sebi's multicap fund rule

We believe quality Mid & Small caps can deliver significant returns in the next 4-6 months as most institutional investors will try to comply with this new regulation, said Centrum Broking

Mid- and small-cap banking stocks such as City Union Bank, Federal Bank, and RBL Bank zoomed around 12 per cent in the early morning deals on the BSE on Monday after market regulator Sebi asked multi-cap mutual funds to invest a minimum of 25 per cent each in Large, Mid and Small Cap stocks, and giving flexibility to the fund manager with the balance 25 per cent.

"In order to diversify the underlying investments of multicap funds across the large, mid and smallcap companies and be true to label, it has been decided to partially modify the scheme characteristics of multicap fund," the Securities and Exchange Board of India had said in its circular on Friday.

The regulator, however, later clarified in a statement on Sunday that apart from rebalancing their portfolio in the Multi Cap schemes, mutual funds could inter-alia facilitate switch to other schemes by unit holders, merge their Multi Cap scheme with Large Cap scheme or convert their Multi Cap scheme to another scheme category, for instance, Large cum Mid Cap scheme.

"Sebi is conscious of market stability and therefore has given time to the Mutual Funds till January 31, 2021 to achieve compliance with the circular through its preferred route of which rebalancing of the portfolio is only one such route," the regulator said.

It is reiterated that to achieve the desired objective of True to Label and Appropriate Benchmarking, Sebi will examine proposals of the industry received in this regard, it added.

Among individual stocks, CUB surged 12.4 per cent to hit an intra-day high of Rs 150.4 per share, while Federal Bank jumped 4.2 per cent. RBL Bank, IDFC First Bank, Bandhan Bank, YES Bank, J&K Bank, Bank of Maharashtra, Indian Bank, Bank of India, and Union Bank were up between 0.15 per cent and 3.45 per cent at 10:00 am. In comparison, the benchmark S&P BSE Sensex was up 0.63 per cent, while S&P BSE Bankex index was ruling 0.49 per cent higher.

Here's what brokerages pick:

Sebi circular on Multicap funds with 25 per cent investment each in Mid/Small caps, analysts say, will create a near term disruption as top 8 multi cap funds have allocation of Rs100,000 crore and the share of large caps is 65-90 per cent and small cap allocation is in low to mid-single digits.

"Given that quantum of Rs220bn flow to small caps in just 4 months, near term uptick in stocks can’t be ruled out although we expect MF’s to undertake scheme organization and categorization to reduce the impact," said a report by Prabhudas Lilladher dated September 13.

While advising investors to adopt a selective approach and focus on companies with strong balance sheets, corporate governance practices, brands, technology and ability to withstand shocks, the brokerage picks RBL Bank, Cholamandalam Investment and Finance Company, Federal Bank, CUB, AU Small Finance Bank, and Nippon Life Asset Management.

"We believe that this regulation change is going to be a game changer for the Indian markets. This can be just the impetus needed by the Mid & Small caps. We believe Quality Mid & Small caps can deliver significant returns in the next 4-6 months as most institutional investors will try to comply with this new regulation," said a report by Centrum Broking.

In the financial space, the brokerage picks Ujjivan Small Finance Bank (target price: Rs 41), M&M Financial Services (target price: Rs 161), and Sundaram Finance (target price: Rs 1,450).

Emkay Global Financial Services, meanwhile, note that these technical demand shocks, if they were to occur, cannot fundamentally change or alter the intrinsic value of companies. "However, we cannot ignore the reflexive impact too – if Mid- and Small-cap companies were to access capital freely and cheaply, it could in turn improve their fundamentals and indeed their intrinsic value as well," the brokerage said in a September 13 note.

The brokerage picks Cholamandalam Finance and Federal Bank from the sector.  

Those at IIFL Securities caution that while this rejig will fuel intermittent rally in broader markets especially small-cap stocks where more funds need to be allocated, the rally in small-cap stocks may be for short term period but small companies with high quality management and strong growth outlook may keep witnessing sustainable upturns. It bets on AU Small Finance Bank and CDSL from banking and NBFC space.