In the third part of the series, we discuss how a limited list of investment worthy stocks along with liquidity pose a challenge to fund managers.
The Indian market is not very deep despite the fancy market-cap and free-float numbers that everyone likes to talk about. Except for a few large-cap stocks, fund managers can find it quite difficult to both build and liquidate large positions in the remaining stocks in the listed space.
Aashish Somaiyaa of Motilal Oswal AMC believes that while managing liquidity is a little easier for large and multi-cap funds, liquidity does limit fund capacity for mid-cap and small-cap funds which stick strictly to their mandate. "If you define a small-cap stock as less than Rs 3,000 crore in market cap and do not want to own more than 1 per cent of any company's equity, then each of your holdings will amount to a maximum Rs 30 crore in your portfolio. Even if you own a 30 stock portfolio, it comes up to Rs 900 crore. In mid-caps, you will end up with the fund capacity at about Rs 4,000 crore or so. Today, many new IPO listings, such as ICICI Life or ICICI Lombard are listing directly as large-caps and the mid-cap or small-cap universe is not expanding that much," he observed.
Vetri believes that liquidity constraints also restrict your stock choices. "In open-ended funds, the liquidity demands can be both ways on a daily basis. So, if you keep taking your AUM up and want to own 6 per cent to 7 per cent in your top stock position in a large fund, then those bets need to come from the Rs 50,000 crore plus market-cap range, where there are only about 50 odd names from which you can make your choices. Taking mid-cap positions in a gigantic fund is also difficult. In a Rs 30,000 crore fund, for instance, even a 0.5 per cent position is Rs 150 crore, which isn't easy to build or liquidate in many mid-cap stocks."
"Fund capacity has to be inevitably linked to the underlying liquidity of the positions. When we launched our first equity fund at Quantum, we back-calculated the fund size we can handle based on trading volumes in the market. Even for our current fund size, we don't buy stocks that do not offer a minimum trading volume of $1 million a day," says I V Subramaniam, Director, Quantum AMC.
Even if a stock offers ample liquidity, one problem with running a jumbo fund is that it can end up becoming a very big stakeholder in many of its portfolio companies, complicating investing decisions.