Can HDFC merger create obstacles for MF holdings?

HDFC Bank, in its Analyst Day meeting held last month, emphasized how it is gearing up for new growth opportunities with upcoming merger with HDFC. On the other hand the equity schemes fund managers might need to grapple with significant concerns that comes with this merger.

For those who are unaware, the HDFC-HDFC Bank merger is expected to be completed in the upcoming weeks. The two announced the merger in April 2022.

Current position
Equity mutual fund managers may face hurdles due to the upcoming merger between Housing Development Finance Corporation and HDFC Bank, as most of them currently struggle to beat or even meet returns generated by their respecitive benchmarks.

The benchmark Sensex and Nifty 50 indexes’ combined weight after the merger is probably substantially larger than what active mutual fund (MF) schemes are allowed.

If HDFC Bank shares outperform the markets, this may have an impact on equity mutual funds’ performance since the schemes will have to maintain an underweight position in the stock to stay under the holding limit capped by Sebi.

Holding limit
Many mutual fund houses hold both HDFC and HDFC bank as part of their portfolio of several active schemes, especially large-cap mutual fund schemes.

So, it is no surprise that many managed equity mutual fund schemes have combined allocations in these two organisations that are beyond 10%.

Notably, the merger would increase their holdings of one security for such schemes to above 10%. This is especially true for several actively managed focused funds, value funds, large-cap funds, and ELSS.

To be in compliance with SEBI regulations, actively managed equities mutual funds must limit their holdings in a single security/stock to 10% of their assets under management (AUM).

As per the market experts, SEBI is unlikely to provide mutual funds a special exemption if they exceed the 10% cap (the maximum allowed holdings in a specific share) following the merger of HDFC Bank and HDFC Ltd.

Impact on investors

Ahead of the merger, specific mutual fund companies and schemes have already started to reduce their exposure to the two companies.

Market experts believe that investors in mutual fund schemes with strong exposure to these equities may not see any disruption due to the combination of HDFC Bank and HDFC Ltd.