Mutual Funds Scheme Consolidation

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To select schemes, investors will have to look at fund manager credentials, stock selection capabilities, duration and credit management across rate cycles with regard to debt schemes.                    

The move by market regulator SEBI to categorise and rationalise mutual fund schemes is a practical step. It simplifies and standardises mutual fund offerings, rationalises the number of schemes offered and helps investors make better decisions.

Here are the key takeaways of the move:

1. It simplifies and standardises mutual fund offerings not just by classifying mutual funds across specific categories like equity, debt, hybrid, solutions oriented and others, but it also defines the investment mandate of each scheme.
   • Equity schemes have been classified into 10 different buckets (besides index funds) from large cap funds to sector funds
   • Debt schemes have been classified in to 16 different buckets, from liquid fund to long duration fund to credit risk fund
   • Hybrid category is demarcated in to six buckets from conservative hybrid fund to aggressive hybrid to dynamic asset allocation to multi asset fund. Interestingly the multi asset fund is redefined as the one that invests in minimum three asset class with minimum allocation to each being 10% (foreign securities will not be treated as an asset class).
   • Solution oriented funds offer investment solutions for children and retirees and
   • Others category define guidelines for index funds and fund of funds (both overseas and domestic)   

1. It rationalises the number of schemes offered by fund houses since no asset management company can have more than one fund per category. This leads to merging of certain schemes with more or less same investment mandate within the fund family. Furthermore, certain schemes are transitioning into new investment mandates – a fund house offering two large cap funds will not have to merge these schemes or may change the mandate of one fund. One of the large cap funds can now be a multicap fund, etc.

1. It enables investors to not just to make right peer group comparison with different fund categories, but also have clearer asset allocation strategies in place. For example, the circular defines a company that falls within the first 100 companies in terms of full market capitalisations as large caps, midcap if it falls between the 101st and 250th company and small cap if beyond the 250th company.

This new norm has sound and lasting benefits for both fund managers and investors in the long run as it leads to better defined investment strategy of funds and easier evaluation of such funds on investor's part. However in the near term, it poses a few challenges to both sides of the investment community. Fund managers have to re-orient their portfolios as per the new mandate and investors will have to review their fund holdings that have undergone change in investment strategy or merged into a fund that has a new investment objective.

For fund houses that have re-classified their product portfolio as per the new norms, it has led to certain schemes undergoing change in the fundamental attributes. For example on the equity side, a fund that used to predominantly invest in top 100 companies by market capitalisation is categorised as focused equity fund that can invest in no more than 30 stocks across market capitalisation now. Similarly, on the debt side, a fund investing mainly in AA and below rated bonds is re-categorised as ultra-short term fund.

Fundamental changes in the attributes of the scheme will lead existing investors to review allocations to such schemes so as to avoid any mismatch in investment objective and the scheme. To elaborate, funds undergoing change in investment objective/strategy will pose a challenge to investors that used to rely only on past history for investment decisions. An erstwhile multicap fund may now be a midcap fund offering different risk-return dynamics to investors.

Investors will have to add a qualitative layer of assessment in their fund selection criteria, i.e. fund manager credentials, stock selection capabilities with regard to different buckets of market capitalisation definition, duration and credit management across rate cycles with regard to debt schemes, etc. Investors will also have to make smart assessment of their existing portfolio and make adjustments accordingly over time to avoid any adverse tax impact.

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