Published Article Details

Why new categorisation of mutual funds is a step in the right direction

Posted by: Uma Shashikant on Oct 16, 2017, 06.30 AM IST

A long-standing bugbear for mutual funds investors has been product proliferation. Too many products, too many names, and too little systematic basis to figure which fund belonged where, and should therefore be compared with which benchmark and with which peer group. If every instance of under or over performance is explained away by how the fund is “different”, it does not do much for investor confidence in the product.

At a time when systematic investment plans are widely known and accepted as a desirable method to save and invest, Sebi’s circular that asks for specific and clear categorisation of schemes is a step in the right direction. How would the new classification scheme help the investor? 

Let’s consider large-caps. The core portfolio of a long-term investor should ideally be invested in large-cap funds. The problems investors had in choosing a suitable large-cap fund were many: There was no standardized definition of which stocks would qualify as large stock; how much of the fund’s assets should be invested in such stocks was not specified; and fund houses had many products that were flexi-caps or multi-caps that could invest in any product, highlighting the segment that did well at a specific time. 

How did these practices affect the investor? It was very difficult explaining the performance of a fund compared to its benchmark, or its peers. Even creating a definitive peer group of funds from which to choose a good fund was not an easy task. A fund could call itself a large-cap fund, while investing a small portion in mid- and smallcaps, thus generating a better return during times when such a strategy paid off. To an investor, discerning whether the fund was a consistent performer or not turned out to be a tough task.

Now, large-cap stocks have been defined to mean the top 100 stocks in the market, ordered by their market cap. A fund that calls itself large-cap cannot invest in any other stock outside of this universe. We will soon have a benchmark index that tracks these stocks, and investors who seek a simple and basic exposure to established businesses as a strategy to invest in equity, will know which product to look at. Fund performance will derive from the ability to choose from this universe, and the weightage of the chosen stocks in the portfolio. That is how it should be. A fund cannot offer more than one product that it can label as a large-cap fund. All other similar schemes that it may have, should be merged with this one large-cap fund. 

Sebi has listed eight such categories for equity funds. Large-cap fund, mid-cap fund (investing in the 101st to 250th stock, according to size) and small-cap fund (investing in the 251st stock and smaller) are the three core categories. A fund house can offer a large-and-mid-cap fund, but such a fund should invest at least 35% in each of these segments as already defined. Investors who want a mixed bag have the choice of a multi-cap fund. Investors seeking a specific strategy can choose from a focused fund (not over 30 stocks), a dividend yield fund, a value fund or a contra fund, and a sector fund. All equity funds should have at least 65% invested in equity, while tax saving funds and sector funds should have at least 80% in equity.

The ranking and rating of equity funds will be much easier to understand and follow, given the clear categorisation. If a fund is called a five-star mid-cap fund, an investor will know that this fund invests all its assets in a specific segment, and it is among the top 10% in its category. If such a fund does better than its peers over a consistent period, investors will be able to choose the fund with confidence. 

The other segment where the categorisation significantly helps the investor is balanced funds. These are pre-packaged combinations of equity and debt, and are used by investors to invest in an asset allocation that serves their need. However, the risk, return and performance of this category of funds depends on the changing proportion in which they invest in equity or debt. 


It can be argued that a fund manager should have the discretion to defend the equity allocation from risks, by increasing the allocation to debt when he expects a market correction; or that a fund manager should be able to benefit from a higher return offered by equity by increasing the allocation at an opportune time. However, investors in this category of products are typically conservative compared to those who invest in a pure equity product. The swinging returns, or the skipped  dividends of a monthly income fund, do not contribute to their confidence in the product.

Sebi now requires these products to have three primary classifications: A conservative hybrid fund will invest 10%-25% in equity; a balanced hybrid fund will invest 40%-60% in equity; and an aggressive hybrid fund will invest 65%-80% in equity. a balanced hybrid fund will invest 40%-60% in equity; and an aggressive hybrid fund will invest 65%-80% in equity. Investors who seek strategic options in this category have a choice of dynamic allocation funds (flexible percentages), multi-asset class funds (more than two classes), arbitrage funds and equity saving funds (equity and derivatives). 

The disappointment in the categorisation is in the debt fund segment—16 categories in all. Since institutional investors who will only choose a category that fits the specific mandate of their organisations, there are too many variants. To the retail investor, a liquid fund that enables parking short-term funds and a dynamic bond fund that invests based on the current opportunities that the debt market offers, might be adequate. We may be able to define this better when performance numbers under the new categorization is available. 

Fund houses have two months to present to Sebi their plan to re-classify their products and a three-month window after approval to complete the process of having just one fund under each category. Expect your fund to send you notices about fund mergers and tell you how your fund is now going to have a different name. Speaking of which, let’s not expect miracles. You will still find fancy names and catchphrases. What you need to tune into is the byline. The description that must mandatorily appear below the name. That must be one of the categories that Sebi has specified. That is the content, the rest is packaging.

The writer is chairperson, Centre for Investment Education and Learning.
Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com. 









 

 

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