As small cap valuations enter dangerous territory, Sebi tells fund houses to get cautious. Details here

livemint.com:

small cap stocks have run up too much, thus entering the dangerous territory, mutual fund houses and market regulators have started to get circumspect. While some fund houses such as Kotak Mutual Fund have imposed restrictions on lump sum investment in their small cap fund; markets regulator Sebi — at the same time — has introduced stress tests for the fund houses to undertake amid growing concerns about valuations of small cap stocks. The Securities and Exchange Board of India has reportedly asked the mutual fund houses that operate smallcap funds with a large corpus to share data on their holdings in the total free float of smallcap stocks, reported Reuters.

Notably, two other fund houses, in July last year, imposed restrictions on investing in their small cap schemes in lumpsum. One was Tata Mutual Fund House and the second Nippon Mutual Fund. Some small cap funds have given exceptional returns in the past one year, as high as 70 percent, thus garnering more inflows of retail investors.

The regulator wants fund houses to undertake stress tests amid a surge in inflows into small cap schemes. Free Float refers to the quantum of freely available shares for trading on the stock market. Typically, shares held by public investors and those not under any lock-in are considered free float.

Large mutual fund ownership in a low-free-float stock can create liquidity issues, especially during periods of market downturn. ALSO READ: Why should large caps be part of your investment portfolio? Experts answer “Sebi wants to determine how much illiquidity there is in the market. If all the funds have holdings in a limited set of companies and there is no free float, then it could be an issue.