The Securities and Exchange Board of India (Sebi) is reviewing the current stock categorisation framework followed by actively managed equity mutual funds (MFs) to ensure they are true-to-label.
Individuals familiar with the matter said the universe of largecap and midcap stocks could be expanded by 25-50 stocks.
The move follows concerns raised by industry players that the current threshold has been skewed following a sharp run-up in the domestic markets after the Covid-19 pandemic.
At present, the top 100 stocks by market capitalisation (mcap) are labelled as ‘largecap’, and the next 150 falls into the ‘midcap’ bucket.
The rest of the listed stocks fall into the smallcap bucket.
MFs are now in discussions with Sebi to expand the largecap universe to the top 125 or 150 stocks and the next 200 as midcaps, said people familiar with the matter.
The expansion in the largecap and midcap buckets, according to MF executives, would make more sense right now as liquidity has significantly improved in the smallcap space since the introduction of the framework in 2017.
Since then, the -cap of the larger smallcap companies has grown multifold.
According to the latest stock reclassification announced by the Association of Mutual Funds in India (Amfi) last month, companies with an mcap of less than Rs 22,000 crore qualify as smallcaps.
This figure stood at just Rs 8,500 crore in December 2017. Similarly, the upper threshold for the midcap basket has gone up from Rs 29,000 crore to Rs 67,000 crore.
According to fund managers, the changes in classification will give more flexibility to active fund managers to construct their portfolios.
In recent years, most active fund managers have failed to beat their benchmarks.
“One of the reasons has been the small universe.
"In such a case, fund managers have limited room to add active weight to their portfolio,” said a senior fund manager.
Active weight is the percentage of a portfolio that is different from the benchmark.
Some say a change in the framework could lead to near-term issues for midcap and smallcap fund managers.
“Since the largest 25 companies in their universe will move out, most fund managers will have to do major rebalancing,” he said.
Going by the present Amfi list, the larger impact will be seen in the midcap space.
Assuming that the largecap and midcap universe is expanded by 25 stocks, the upper limit for largecaps will reduce from Rs 67,000 crore at present to Rs 51,000 crore.
Similarly, it will reduce from Rs 22,000 crore to Rs 20,000 crore.
The cut-off drops even more if the universe is expanded by 50.
Market players say even the Rs 51,000 crore and Rs 20,000 crore cut-offs are fairly high for largecap and midcaps, respectively, and there is scope to expand the universe further.
According to reports, smallcaps in India are now getting larger than the global standards.
ICICI Securities, in a report in December, said that many smallcap stocks in India are now larger than the global size interval of Rs 2,500 crore to Rs 16,000 crore.
The brokerage had argued a transition to a size-based approach as opposed to a rank-based approach currently followed.
“As the economy expands along with more new listings in the largecap and midcap space, the 251st ranked stock’s mcap (the upper threshold for smallcaps) will continue to expand and may not conform to global standards.
"Hence the current methodology of rank-based approach may need to transition to a fixed interval method based on judgment at some point in time,” ICICI Securities said in its report.
