Whalesbook
Outdated Norms Under Scrutiny
The Securities & Exchange Board of India (Sebi) is preparing to overhaul the classification norms governing large, mid, and small-cap equity schemes. These regulations, first put in place in 2017, are increasingly seen as anachronistic given the substantial expansion in the market capitalization of smaller companies. This situation has prompted concerns among mutual fund houses regarding investment mandates and investor clarity.
Motilal Oswal Pauses Inflows
Earlier this month, Motilal Oswal Asset Management Company halted fresh inflows into its Motilal Oswal Nifty Microcap 250 Index Fund. This decision followed consultations with Sebi concerning the alignment of the fund's strategy with existing categorization rules, which do not recognize micro-cap as a distinct category. The fund, launched in June 2023, had amassed approximately ₹2,600 crore in assets by early January, investing in stocks beyond the top 500 by market cap.
Rapid Market Capitalization Growth
Data indicates a significant shift in market valuations. A study by Ventura found that companies in the lower deciles of the listed universe have exhibited the fastest median market capitalization compounding. Between June 2020 and June 2025, stocks ranked 251st by market cap increased by 4.4 times, the 500th by 6.1 times, and the 750th by 7.3 times. Approximately 83% of small-cap fund portfolios are invested within the top 750 stocks as of November 2025, with the core small-cap segment (ranks 251-750) accounting for 63%.
Liquidity Concerns and Investor Perception
Industry participants note that the regulator's concern stems from the potential for microcap stocks to lure investors with rapid upside, only to face drastically reduced trading volumes during market downturns. Pratik Oswal, Head of ETFs and Index Funds at Motilal Oswal, countered that today's microcaps possess significantly more liquidity than small caps did a few years ago. He believes funds can comfortably scale beyond their current size without liquidity issues.
Industry Perspectives on Classification
Juzer Gabajiwala, Director at Ventura, pointed out that many stocks perceived by investors as large- or mid-cap are, by AMFI classification, still considered small-cap. He cited examples like CDSL, Gillette India, NBCC, PNB Housing Finance, Wockhardt, East India Hotels, Angel One, and Tata Chemicals, which investors often categorize higher than their official small-cap status. Despite small-cap funds delivering negative returns of approximately 2.4% between December 2024 and November 2025, the category saw net inflows of ₹53,165 crore, underscoring a belief in long-term potential.
Sebi's Path Forward
Sebi Executive Director Manoj Kumar acknowledged the challenge of creating long-term feasible categorizations. While the introduction of a micro-cap category has been suggested, Sebi has intervened in such cases recently, indicating caution. The regulator aims for a framework that, while potentially not universally accepted immediately, will foster long-term stability. Industry participants suggest classification criteria should follow international best practices and utilize a percentile method rather than simply a count of stocks.