HDFC-HDFC Bank Merger: What will happen to my mutual fund investment?

The HDFC-HDFC Bank combined entity weightage in the Nifty 50 is expected to cross the 10% stock holding limit. Will this lead to large-cap funds underperforming the benchmark? Read on to see what fund managers and investors can do about it.

HDFC-HDFC Bank merger

On 4 April 2022, investors woke up to some positive news they had been waiting to hear for the past many years. The HDFC group announced the merger of HDFC Ltd and HDFC Bank. Investors received the proposed merger news with enthusiasm, resulting in a spike in HDFC share price and HDFC Bank share price.

The proposed HDFC-HDFC Bank merger will impact shareholders, depositors, borrowers, and mutual fund investors. This article will focus on how the proposed merger is expected to affect mutual fund investors.

Weightage of the merged entity

As of 31 March 2022, HDFC Bank had a weightage of 8.43% on the Nifty 50 Index, and HDFC Ltd had a weightage of 5.66%.

Also Read: Mutual Funds Versus Shares - Which One To Choose?

Table: Top 10 constituents of Nifty 50

Top 10 constituents of Nifty 50

Going by the table above, the weightage of the combined entity comes to a little more than 14%. An individual stock’s weightage above 10% can be a challenge for active fund managers.

SEBI’s 10% stock limit regulation

SEBI has prescribed a maximum holding limit of 10% for individual stocks in diversified mutual fund schemes. As per this limit, a diversified mutual fund scheme cannot invest more than 10% of its total assets in a single stock. Many mutual funds are currently holding HDFC Limited and HDFC Bank shares individually. But, when the entity is merged, the limit of 10% will be exceeded in the case of many mutual fund schemes.

Also Read: Focused Funds Vs. Mutual Funds: Which One To Choose?

Chart: Schemes with more than 10% combined holding in HDFC Bank and HDFC Limited

Schemes with more than 10% combined holding

As of 4 April 2022 (the merger announcement date), 16 mutual fund schemes had more than 10% combined holding in HDFC Ltd and HDFC Bank. Once all the requisite bodies approve the merger, if the combined entity's weightage in the Nifty 50 Index is higher than 10%, schemes with more than 10% exposure will have to reduce their stake.

What will be the impact of HDFC-HDFC Bank merger on MF scheme returns?

When a stock with a weightage of more than 10% outperforms, it will impact the mutual fund scheme returns as their exposure will be limited to 10%. It will be difficult for fund managers to outperform the index and generate alpha for their investors in such a situation. In fact, it can lead to underperformance of the mutual fund scheme compared to the benchmark. 

Earlier, in 2020, the weightage of Reliance Industries in the Nifty 50 Index had reached 14%. But diversified equity funds had to restrict their exposure to 10%. During this period, the RIL stock outperformed, going up by 150%, resulting in mutual fund schemes underperforming the Nifty 50 Index.

HDFC-HDFC Bank merger: What should investors do now?

Public shareholders don’t need to do anything as of now. The HDFC group will need to take the approval of various regulators such as SEBI, RBI, IRDAI, stock exchanges, Competition Commission of India (CCI), shareholders of both companies, etc., to conclude the merger. The entire process could take 16-24 months. 

After the conclusion of the merger, only HDFC Bank shares will continue to trade. At that time, the fund managers will have to bring down their stake in the combined entity to below 10% if there is no change in the SEBI guideline. As an investor, you will have a choice to continue investing with the scheme or redeem.

One expert view is that the weightage of the merged entity will breach the 10% limit due to corporate action and not a fund manager's decision. In such a case, the fund managers may not be required to reduce their stake in the combined entity. It’s up to SEBI to clarify. 

Also Read: What Are Thematic Funds?

Lastly, the 10% limit rule does not apply to index funds, exchange-traded funds (ETFs), and thematic funds. So, if you wish to have exposure to the HDFC-HDFC Bank combined entity as per weightage in the Nifty 50 Index, you can invest in a Nifty 50 Index Fund.

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