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    Sebi move triggers Lollapalooza Effect on D-Street: What to buy now?

    Synopsis

    Charlie Munger, an American businessman, investor and partner of legendary investor Warren Buffett, coined the term ‘Lollapalooza Effect’ in reference to a situation when multiple factors come together and create a strong tail for a stock to go up.

    Rise-9---istockiStock
    According to ICICI Securities, currently the earnings yield spread of micro, small and midcaps over largecaps have increased to 460 basis points, 180 basis points and 110 basis points, respectively.
    Heard of Lollapalooza effect?

    The Sebi move to tweak the investment rules for multicap funds will now trigger this effect in the domestic equity market, with the smallcaps likely to see tremendous buying pressure.

    ICICI Securities, India’s leading brokerage, speculated on the prospects of such an effect on domestic stocks after Sebi on Friday tweaked the rules for multicap funds.

    The market regulator said effective January 31, 2021, multicap funds will have to invest a minimum of 75 per cent of their total assets in equities, with 25 per cent each in smallcap, midcap and largecap companies.

    On Sunday, the markets regulator issued a clarification, saying mutual funds will have many options to meet the new requirement on asset allocation, based on the preference of their unit-holders.

    Apart from rebalancing the portfolios of multi-cap schemes, mutual funds can also facilitate a switch to other schemes by unit-holders, merge multi-cap schemes with large-cap ones or convert their such schemes into another scheme category, such as large-cum-midcap scheme.

    What is Lollapalooza effect?
    Charlie Munger, an American businessman, investor and partner of legendary investor Warren Buffett, coined the term ‘Lollapalooza Effect’ in reference to a situation when multiple factors come together and create a strong tail for a stock to go up.

    Sharing his thought on the investing jargon, Munger once said: “When three or four tendencies were operating at once in the same situation, the outcome wasn’t linear; it was straight up.”

    How will it benefit smallcaps?
    Explaining the concept of Lollapalooza Effect and factors that may work in the broader market, Abhishek Basumullick, Kolkata-based investor and Founder of Intelsense, said smallcaps are heading for a ‘Lollapalooza Effect’, which means small independent factors would combine to produce an outsized outcome. “Factors like very less liquidity, low overall market-cap, very few well researched companies in the smallcap universe and the small duration in which multicap funds need to realign their portfolios can create a significantly outsized return within a short span of time,” he said.

    Multicap schemes of mutual funds had an asset under management (AUM) of Rs1.47 lakh crore as of August 2020, with 74 per cent of the corpus invested in largecaps, 16 per cent in midcaps and only 6 per cent in smallcaps. Sebi’s new rules will entail multicap funds to increase their holdings in midcaps by 9 per cent (Rs 12,700 crore) and in smallcaps by 18 per cent (Rs 27,000 crore) while reducing their allocation to largecaps by 24 per cent (or Rs 35,500 crore) over the next five months.

    “You are going to see a lot of action in companies having market-caps between Rs 3,000 crore and Rs 7,000 crore,” said Abhimanyu Sofat, Head of Research at IIFL Securities.

    Top stocks to buy
    Midcap and smallcap stocks peaked out in January 2018, and since, then they’ve had a poor run. According to ICICI Securities, currently the earnings yield spread of micro, small and midcaps over largecaps have increased to 460 basis points, 180 basis points and 110 basis points, respectively.

    Earnings yield is defined as inverse of the price-earnings ratio. In theory, if the earnings yield is higher, stocks may be considered undervalued.

    The BSE Midcap and Smallcap indices have declined up to 25 per cent since January 2018, while the benchmark BSE Sensex has gained 15 per cent.

    IIFL Securities said companies like AU Small Finance, Jubilant Foodworks, SRF, Bharat Electronics, Ramco Cement, Balakrishna Industries, PFC, TVS Motors, Voltas, CESC, Crompton Greaves Consumers, REC, KEC International, MCX, Sheela Foams, IndiaMart Intermesh, Kalpataru Power, BEML, Bharat Dynamics and Strides Pharma should benefit post the Sebi decision.

    At the same time, some analysts said investors should be very careful and choosy, as buying into poor quality companies during a market frenzy can end up becoming a near-perfect trap, from which you may not be able to exit without substantial losses.

    ICICI Securities has ‘buy’ rating on stocks like Balkrishna Industries, ACC, Trent, Apollo Hospital, TVS Motors, Mphasis, Cholamandalam Finance, Zee Entertainment, Ramco Cements, AIA Engineering, L&T Technology Services, Dr Lal Pathlabs, BHEL, Cummins India, Aditya Birla Fashion, Gujarat State Petronet, JK Cement, Aavas Financiers, Federal Bank, Visaka Industries, ENIL, Somany Ceramics, Fortis Healthcare and CreditAccess Gramin, among others.



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    (What's moving Sensex and Nifty Track latest market news, stock tips and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more
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