Inclination towards small-cap must be seen with risks linked: Sebi WTM

The Sebi whole-time member also asked the MF industry to keep robust checks on its commissions for distributors to avoid a perverse incentive system or malpractices and missellings

The growing interest in smallcap stocks by mutual funds (MFs) must be considered in light of the associated liquidity risks, cautioned Ananth Narayan, whole-time member (WTM) of the Securities and Exchange Board of India (Sebi).

The remarks from the Sebi official come at a time when net inflows into smallcap equity funds for the quarter ending in September have topped Rs 11,000 crore. However, inflows in September have dropped by 37 per cent month-on-month to Rs 2,678 crore.

“In March 2020, 8.6 per cent of the total non-promoter holdings in smallcaps were in the hands of MFs. Today, that figure stands at 19 per cent. A simple risk metric for all of us is to ensure that the liquidity in the underlying market can support the level of holdings held collectively in that particular segment,” Narayan said while speaking at an MF summit organised by a financial portal.

The increased interest in smallcap stocks is due to the high returns achieved so far this year.

Since January, the National Stock Exchange Nifty Smallcap 100 Index has surged by over 32 per cent, while the Nifty50 has gained 9.4 per cent year-to-date.

Narayan cautioned the industry by highlighting the issues that debt MFs faced with redemptions “when their holdings exceeded the underlying liquidity in the secondary market”.

“There are no problems in the smallcap sector today, but that’s why it’s the right time to discuss these risks,” added the Sebi official.

Last month, research firm Kotak Institutional Investors also warned investors about the rising prices of smallcap stocks, describing it as “irrational exuberance with 'no meaningful fundamental change”.

The Sebi WTM also urged the MF industry to maintain strict oversight of commissions for distributors to prevent a perverse incentive system, malpractices, and mis-selling.