In 2017, SEBI in an effort to bring uniformity in the Mutual Fund industry announced a major change – now mutual funds are categorized so apple can be compared with apple.
If I talk about my 15 years career in the personal finance industry – I think this is the biggest change I have seen in Mutual Funds.
This will have a huge impact on existing investors & even on asset management companies. I may not 100% support this but still, this was required to tame the animal instincts of the fund manager.
Some time back I wrote – Mutual Fund Pollution & how to control. I am not sure if SEBI read this before taking the final decision 😉
The five broad groups of Mutual Funds after Categorisation are –
- Equity Schemes – Investments in equity and equity related instruments
- Debt Schemes – Investments in debt instruments
- Hybrid Schemes – Investments in a mix of equity, debt, and other instruments
- Solution Oriented Schemes – Investments in specific schemes like retirement schemes.
- Other Schemes – Include other categories such as ETFs, Index Funds and Fund-of-Funds
In each group, there are sub-categories and the MF houses have to ensure they invest in a manner that justifies the scheme being in a particular category.
For example, Large caps and Small Caps are two of the multiple categories in the equity schemes category. The MF house has to ensure that the scheme categorized as ‘Large Caps’ has at least 80% of investment in large caps. Similarly, the scheme marked as a ‘Small Caps’ scheme should have at least 65% of investment in small-cap stocks.
The good part is now large-caps, mid-cap & small-cap stocks are clearly defined – so the universe of stocks is clear for all mutual funds.
In the case of Debt schemes too, there are many sub-categories. Liquid Fund is a sub-category that caters to investments with maturity up to 91 days. If a scheme is a Long Duration Fund, the portfolio should have a maturity of more than 7 years.
SEBI has issued a circular for the complete description of all categories and sub-categories.
The reasons for Mutual Fund Categorisation
- Many MF houses had multiple schemes with fancy names but were pretty much the same in terms of portfolio and scheme management. This does not help investors much but helped MFs increase their customer base. It is an attempt to curb mis-selling.
- Many schemes had misleading names that gave the wrong impression on returns, guarantees etc. This led customers to take more risks than they should
- A uniform categorization of funds across MF houses helps customers compare similar schemes of different houses in an easier and better way. It helps bringing in transparency.
Must Read – Risks in Mutual Funds
The impact of these changes on the retail investor
- Accurate Comparison of Schemes – Retail investors can compare schemes better. Earlier the scheme name could be misleading or unclear. The descriptions of different ‘large-cap funds’ were different. Now schemes in a category can be compared objectively as they will have similar characteristics.
- Awareness of Investments – Many times, retail investors are not clear on what they are investing in. Many times, they invest in different schemes but find out that both schemes are pretty much the same. This uniform categorization will help in him being more aware and be able to take better investment decisions.
- Performance – In the short run, there could be changes in the scheme’s portfolio which could affect the performance. Some might outperform and some may underperform. Many fund managers used to tweak the portfolio to get higher returns. For example, in a large-cap fund, the fund manager would have increased the allocation in mid-cap stocks in certain market conditions to get alpha returns. This may not be easily possible now. Fund managers have to adhere to the categorization strictly.
- Better Clarity on Investment – The retail investor will have a better picture of how his funds are invested as the categorization is accurate. The fund manager will not be able to drift to investments that do not suit the MF scheme intent or objectives.
ONE MAJOR IMPACT THAT WE MAY REALISE LATER – Categorisation & Rationalisation have a major impact on alpha generation capabilities of ‘active’ funds. Even fund managers are secretly accepting that it will be tough for them to generate alpha in large-cap funds. I keep saying Alpha Gone Index On. I think the time has come to introduce at least 5-10 % large cap index fund in your portfolio. Check an old article on ETF & a recent article on DSP Black Rock Equal Nifty Index Fund.
What Should I Do As A Retail Investor Now?
- Check the Investment Strategy and investment structure. If it has not changed much, you can continue to be invested in the scheme.
- Check the Investment Objective. If it remains same, you need not tweak your MF portfolio. But if it has changed and does not match with your financial goals, you might want to reduce your investment in it or exit from it. But do invest in another MF Scheme that suits your financial plan. Do not let your money remain idle.
- Evaluate your portfolio and see if it matches with your investment plan. The new categorization helps to look at the investments objectively and helps one understand the MF schemes and their investment strategy and structure better. For example, debt funds are more structured right now and this will help you in managing your Debt MF portfolio better.
- If the MF investment strategy has changed a lot due to the re-categorization, it might not make sense to compare with past returns. So you need to evaluate it differently.
- Do not rush to buy and sell MF schemes. Check for a period of 3-6 months as to how your investment portfolio is performing and then take a decision. Unless there is drastic underperformance or significant change in investment objectives, you can adopt a wait and watch policy.
- Check the expenses you will incur in case you exit out of certain schemes and enter other schemes. There was a period of exit window available during which no exit load will be charged if applicable. Also, consider taxation.
The new classifications might have short-term upheaval but in the long-term it is a step towards arming investors with more knowledge and bringing uniformity in the MF industry.
Let me know if you have already rejigged your portfolio. If you have any questions – feel free to add in the comment section.