SEBI multi-cap reclassification 2020

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The SEBI multi-cap reclassification of 2020 refers to the reform introduced by SEBI circular SEBI/HO/IMD/DF3/CIR/P/2020/236 dated 6 November 2020, which amended the definition of multi-cap funds within the SEBI scheme rationalisation circular 2017 framework to mandate a minimum 25 per cent allocation each to large-cap, mid-cap, and small-cap stocks, with the remaining 25 per cent at the fund manager’s discretion. Prior to this amendment, multi-cap funds were required to invest only a minimum 65 per cent in equity, with no cap-wise sub-allocation, allowing fund managers to hold predominantly large-cap portfolios in a “multi-cap” fund. SEBI simultaneously introduced a new category, the Flexicap Fund, to provide an unconstrained equity allocation option. The circular was issued by the SEBI Investment Management Department and is grounded in the SEBI (Mutual Funds) Regulations, 1996.

Background

Pre-2020 multi-cap definition

Under the 2017 rationalisation circular, multi-cap funds were defined as:

“Open-ended equity scheme investing across large-cap, mid-cap, and small-cap stocks. Minimum investment in equity and equity-related instruments: 65%.”

This definition gave fund managers total discretion over the large/mid/small allocation. In practice, most multi-cap funds held 60–75% in large-cap stocks, 15–25% in mid-cap, and under 10% in small-cap. The category was effectively a large-biased diversified equity fund with marginal mid/small-cap exposure.

This created two problems:

  1. Category misrepresentation: Investors seeking genuine multi-cap exposure (across the market capitalisation spectrum) were getting primarily large-cap funds.
  2. Benchmark mismatch: Multi-cap funds were benchmarked against Nifty 500 or BSE 500 (which themselves have large-cap dominance), making it easy to appear like genuine multi-cap funds.

SEBI’s observation

By mid-2020, SEBI’s data showed that across all AMCs with multi-cap schemes, the weighted average small-cap allocation was under 8%. SEBI determined that this was inconsistent with the stated category intent and issued the November 2020 circular.

The amended multi-cap definition

SEBI circular SEBI/HO/IMD/DF3/CIR/P/2020/236 mandated:

Sub-asset classMinimum allocation
Large-cap stocks (top 100 by AMFI list)25% of total net assets
Mid-cap stocks (101st to 250th)25% of total net assets
Small-cap stocks (251st and beyond)25% of total net assets
Remaining 25%At fund manager’s discretion (any equity or related instruments)

Total equity minimum remained 75% (revised upward from 65%).

The existing AMFI semi-annual market capitalisation classification (updated every January and July) defines which stocks are large/mid/small-cap, consistent with the 2017 rationalisation framework.

Compliance timeline

SEBI allowed existing multi-cap schemes a compliance window of three months (January 2021) to align portfolios to the new mandate. AMCs had the following options:

  1. Portfolio rebalancing: Buy mid-cap and small-cap stocks to reach 25% each, funded by selling excess large-cap holdings.
  2. Scheme conversion: Convert the multi-cap scheme to Flexicap Fund (new category, see below), Focused Fund, Large & Mid Cap Fund, or another category that better matched the fund’s actual investment style.
  3. Scheme merger: Merge the multi-cap scheme into another existing scheme of the appropriate category.

Introduction of the Flexicap Fund

Recognising that the amended multi-cap definition imposed constraints that many AMCs and fund managers considered suboptimal, SEBI simultaneously introduced a new category:

Flexicap Fund: An open-ended dynamic equity scheme that invests across large-cap, mid-cap, and small-cap stocks. Minimum investment in equity: 65%. No sub-allocation constraints.

This is essentially the pre-2020 multi-cap definition formalised as a distinct category. Each AMC may operate one Flexicap Fund alongside any one Multi-cap Fund (subject to the one-scheme-per-category rule).

Several AMCs converted their existing multi-cap funds to Flexicap Funds and launched fresh multi-cap funds with the new 25/25/25 mandate; others retained their multi-cap funds and rebalanced portfolios.

Market impact

The announcement of the circular on 11 September 2020 (the original consultation paper) triggered a significant rally in mid-cap and small-cap stocks:

  • Small-cap demand: Multi-cap funds collectively managed approximately ₹1.5–2 lakh crore at the time; a shift from <8% to 25% small-cap allocation implied potential purchases of ₹25,000–40,000 crore in small-cap stocks.
  • Front-running concerns: SEBI was aware that announcing the compliance timeline simultaneously with the mandate could cause orderly buying; the three-month window was set to allow gradual absorption.
  • Rotation effect: Large-cap stocks in multi-cap fund portfolios faced potential selling pressure as managers raised cash to buy small/mid-cap.

Post-compliance, multi-cap funds maintained the 25/25/25 mandate, though the dynamic AMFI list creates semi-annual rebalancing needs as stocks migrate between categories.

Ongoing compliance challenges

  • AMFI list updates (January and July): If a stock in the mid-cap bucket rises to large-cap on the July AMFI list, the fund has two months to rebalance. This creates predictable semi-annual flows.
  • Small-cap liquidity: Many small-cap stocks have limited daily trading volumes; compliance with the 25% minimum for large funds requires careful execution.
  • Fund size constraints: Very large multi-cap funds (₹10,000+ crore) face liquidity constraints in small-cap execution; SEBI’s stress testing framework for small/mid-cap funds indirectly applies to the small-cap sleeve of multi-cap portfolios.

See also

References

  1. SEBI Circular SEBI/HO/IMD/DF3/CIR/P/2020/236, 6 November 2020, Multi-cap fund and Flexicap Fund.
  2. SEBI Circular (consultation paper), 11 September 2020.
  3. SEBI (Mutual Funds) Regulations, 1996.
  4. AMFI, “Market capitalisation classification”, amfiindia.com.
  5. SEBI Master Circular SEBI/HO/IMD/IMD-PoD-1/P/CIR/2024/137, 27 May 2024.

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