The new classification of mutual funds is considered a step in the right direction as it will bring clarity, uniformity among mutual funds and make the life of the Indian investor simpler.
By Dasvir Ankhi
There are two basic ways to earn money – by working and by making your assets work for you. While the latter is an idea that each one of us thinks about once we start earning; choosing the right investment strategy assumes paramount importance. As has been rightly said by Ben Graham, noted American investor & ‘the father of value investing, “The individual investor should act consistently as an investor and not as a speculator.”
In India, the influx of the domestic investors’ money in equity markets (mutual funds) has been increasing significantly over the past few years. For those still in woods, a mutual fund is a professionally-managed investment scheme run by an asset management company that accumulates people’s money and invests them in stocks, bonds and other securities. You can start investing in mutual funds from as little as Rs 500. Should you need help finding the right fund, a simple Google search for a good large-cap equity fund would throw up numerous possibilities.
Unfortunately, however, for many first-time investors, having to choose from the plethora of equity funds, all claiming to outperform the index and the benchmark, is like finding a needle out from what literally seems like a haystack of schemes available and registered under the Securities & Exchange Board of India (SEBI). To simplify this, SEBI on October 6th, 2017, released new guidelines on categorizing mutual funds, asking funds to classify their schemes under five clearly defined categories. These categories are classified as Equity Schemes, Debt Schemes, Hybrid Schemes, Solution Oriented Schemes and Other Schemes. Fund houses will be allowed to have one scheme in each category, except for Index funds/ETFs tracking indices, fund of funds and thematic schemes investing in different sectors.
Additionally, all mutual fund schemes within a fund house will need to be appropriately distinct from each other in terms of strategy, asset allocation, etc. If a fund house currently has more than one fund in the same category, they will necessarily need to be merged into one. As of now, fund houses will have to analyze each of their existing schemes, obtain approvals from their trustees and submit their proposed course of action (whether a scheme will be merged, wound up or its fundamental attributes will be changed) to the regulator within the next two months. After SEBI issues its observations on the fund house’s proposals, the necessary changes will have to be carried out within three months.
This move by SEBI is clearly in favour of investors – by standardizing mutual fund categories, new fund offerings are likely to come down, which will clear the clutter and make it easier for investors to compare & identify the right financial instrument to invest in. Comparing funds of a particular category will now be easier, given that there could be similar kind of portfolio with more or less the same holdings but with different allocation. Also, merging of the funds will lead to a reduction in expense ratios which is in turn is beneficial for investors.
This move will also test the fund managers’ stock-picking skills since the basket of funds to choose from is now common. For example, a fund manager of a “large cap fund” could have an allocation in the midcap stocks in order to generate alpha returns. Though this could yield higher returns, it is also important to note that it increases the risk of the fund, thereby increasing the risk for the investor who may not have the appetite for midcap exposure. Although at an overall level, the equity allocation for an investor does not change, what used to change was the sub-allocation towards mid-cap and small cap in his portfolio via various funds held by him. Thanks to the new circular, the fund manager is now restricted in terms of the exposure he can have in each of the categories, thereby bringing the risk down.
This is indeed a great move benefitting investors. Fund houses offered numerous schemes under the same category and made it really confusing for the investors to select from a list of multiple large cap, multi-cap or midcap funds from the same fund house. For a fund manager, this move could limit their freedom by forcing them to exit quality stocks and abide by the norms on market capital holdings. But overall, the new classification is considered a step in the right direction as it will bring clarity, uniformity among mutual funds and make the life of the Indian investor simpler.
(The author is Head-Wealth Management, Distribution and Advisory, Tata Capital)