Sebi's new MF rule will lead to forced inflows into mid and small-caps, says HDFC Securities; lists top picks

However, the brokerage cautioned that this mandate would still lead to forced inflows into mid and small-caps over the next four months, especially small-caps, given the sizeable gap between existing and proposed holdings across most schemes.

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But it further added high divergence of valuations between large caps and mid/small caps that had emerged over the past two years in sectors such as Consumer, IT, Cement, and Financials might normalise to an extent, helped by this catalyst and high retail investor interest.

It advises investors to remain disciplined and stick to fundamentals while selecting small-caps, given the fact that economic headwinds might persist for a while, and valuations for quality mid and small-caps are not mouthwatering after the run-up. The brokerage continues to see selective bottom-up investible ideas with favourable risk-reward across all market caps.

Consumer, IT, Pharma, Chemicals, Cement, and Agri/rural might remain the

preferred sector choice for investors in the near term suggested the brokerage.

However, it also sees this new rule as a potential catalyst for the rerating of ignored stocks in the economy-facing sectors such as Infra/Industrials, Hotels, Auto Ancillaries, Financials and Real Estate, if there is a confluence of strong balance sheets and attractive valuations.

As per current holdings and no scheme reclassification, this shift would lead to an outflow of Rs 35,000 crore from large caps (top 100 stocks by

market capitalisation) and inflows of Rs 13,000 crore into mid-caps (next 150 stocks), and Rs 28,000 crore into small-caps (beyond the top 250 stocks), it added.

"We believe some of the large multi-cap fund schemes might opt to reclassify into (or merge with the existing) “large and mid-caps” category, given the difficulty of managing sizeable AUMs with a high proportion of relatively less liquid Indian mid and small-caps," the brokerage report said.

HDFC Securities' top mid-cap picks are Mphasis, ACC, Crompton Consumer, IGL, Gujarat Gas, Max Financial, JK Cement, Endurance Technologies, Persistent, and Aarti Industries.

Top small-cap picks include CDSL, KNR Construction, Alkyl Amines, Galaxy Surfactants, Radico Khaitan, PNC Infratech, Brigade Enterprises, Sonata Software, Mastek, and Ahluwalia Contracts.

Its model portfolio has a good blend of mid and small caps with a weightage of around 15 percent. It added Persistent Systems, Aarti Industries, Endurance Technologies, and Radico Khaitan to a model portfolio and reduced weightage in ICICI Prudential and Bajaj Finance.