Small and midcap funds: Sebi steps in. When will you?

livemint.com:

Amfi, in response, directed the fund houses: "In the context of the froth building up in the small and midcap segments of the market and the continuing flows in the small and midcap schemes of mutual funds, Trustees, in consultation with Unitholder Protection Committees of the AMCs, shall ensure that a policy is put in place to protect the interest of all investors," the letter read. So far so good. It was brave of Amfi to lift the “froth" line verbatim in its missive to the mutual funds.

Given it’s an industry body, many members of which are still pushing investors to put money in “frothy" funds. Anyway, there’s much to take away from this entire episode. And in this edition of Contramoney, we will do just that.

First, let’s start with Sebi. There’s no doubt that Sebi’s directive is a solid step that will perhaps make an impact. I say perhaps because the regulator cannot really tell you and me what to do with our monies.

It has done what it can do – instruct the industry to act. Now it remains to be seen how they go about doing this. While I do not want to nitpick, my question is this – why so late? Many, including this column, have warned about the flood of money into small and midcap funds (and more recently how it’s being diverted to thematic funds).

Too much money chasing such stocks has naturally led to more froth. On top of that, the funds are now too large, and whether they can give fair exits in case there was a rush to get out, is questionable. Some funds will counter this (probably due to this regulatory action) by increasing allocation to the more liquid large-cap stocks perhaps, or then hold more cash.