SEBI's new mutual fund classification plan: What you should knowThe universe of mutual funds in Indian is quite big; about 2,000 funds managed by 40-odd asset management companies (AMCs). So it’s not particularly easy for an investor, especially a first-time investor, to navigate through it to identify the right kind of mutual fund for her requirements.

One of the major problems is that AMCs started having more than one scheme under each category, citing reasons such as the assets under management (AUM) are too large to handle by a single scheme. This made the exercise of choosing a scheme a troublesome exercise.

So recently market regulator SEBI came out with fresh guidelines as to how mutual funds need to be categorised to introduce clarity. Based on the categories, mutual funds will be forced to either merge, wind down or change the fundamental characteristics of a particular scheme. This move could also have a short-term impact on the portfolio of any investor depending on the schemes they have currently invested into.

So what are the classifications that SEBI plans to introduce?

At the highest level, all mutual funds will be classified into one of the following five categories:

  1. Equity
  2. Debt
  3. Hybrid
  4. Solution Oriented
  5. Other

However, each of these categories will have sub-categories:

  • Equity will have 10 sub-classifications
  • Debt will have 16
  • Hybrid will have 6
  • Solution Oriented will have 2
  • Others will have 2 sub-classifications.

That is a grand total of 36 classifications an investor can choose from.

While the intent is to provide well-defined choices and clarity to an investor, every action has a reaction. As such, these new classifications will have varying impact on existing funds and consecutively on an investor portfolio. Such impacts could include:

  • Better choice by fewer options:  With AMCs forced to ensure one scheme per category and fund labelling to be made in line with investment strategy, options will become lesser which should result in investors being more aware of their choice.
  • Schemes will be forced to stick to their mandate: Funds often change their investing style based on market conditions. For example, a large-cap fund may have sizeable mid-cap exposure because of its chasing higher alpha. But now, any drastic change will force the scheme to change its characteristics resulting in the same being communicated to the investors. So now the investor will not have to worry about the fund becoming something it originally was not set out to do.
  • Like for Like Comparison: As AMCs will have one scheme per category, it will be easier for the investor to compare the options available. All schemes of different AMCs of a category will have similar styles and characteristics, which will result in a “apples to apples” comparison.
  • A possibility of reduction in performance: Like mentioned above, funds often change their investing styles to generate significant alpha. But after these regulations, alpha creation may be more difficult as the universe of stocks will be same for all schemes in a category. Furthermore, as per the latest mandate, if a fund wants to be categorised say as a large cap, it will have to invest only stocks defined as large-cap as per regulations. So in the short term, it may have to sell or buy some stocks which could have an impact on cost that would be borne by the investor. Also, as regulations would demand funds to rebalance their stocks as per the semi-annual publications of AMFI which enlist large, mid and small-cap stocks, it may result in forced selling to accommodate any change in the status of a stock, resulting in a possible negative impact on the performance of the fund.
  • Need for review in the short term:  With the latest mandates, one can expect a short period of fund houses realigning their products. As such, many schemes may end up being quite different from what they originally were. Therefore, investors may need to keep a thorough eye on their funds to watch out for any changes that may occur and act accordingly.

Overall, while there may be short-term practical hurdles for both investors and fund houses alike while adjusting to the new mandates, the general consensus has been that this move is a positive step taken by the regulators as it will bring reliability and simplicity to investors.

Author
Debendra Das

The author is a private wealth manager and financial advisor. The views are his own. Feedback to this article may be sent to contact@rupeeiq.com.