What impact Sebi’s categorisation and rationalisation scheme will leave on your mutual fund portfolio

The Securities and Exchange Board of India (Sebi) recently released a circular on categorisation and rationalisation of mutual funds, MFs, to ensure different schemes are clearly distinct in asset allocation, investment strategy etc. The market regulator wants to bring uniformity in the characteristics of similar schemes to ensure an investor is able to evaluate various options before making any investments.Before this, there weren’t any standard definitions of MF categories. MFs were free to determine a scheme’s characteristics and investment strategy while seeking approval from Sebi to launch a fund, within a broad framework. As a result, MF companies, research and advisory firms came up with their own definitions and methodologies of categorising funds.Further, MFs launched multiple schemes with similar strategies. For instance, currently there are around 280 open end equity funds including 65 to 70 large cap funds and a similar number of flexi-cap schemes, depending on the category definitions used, across 42 Asset Management Companies (AMCs) indicating multiple schemes with similar strategies being launched by AMCs.

Non-standard or ad hoc category definitions and the large number of schemes makes it difficult for advisors and investors to meaningfully evaluate and compare funds and select suitable one for investment.For instance, an AMC might consider one of its equity funds as large-cap, but an advisor might categorise it as a flexi-cap or diversified equity fund based on its methodology, hence creating confusion and making comparison with other funds difficult.The circular defines broad groups within which AMCs need to classify their existing funds. The broad groups are as follows:Equity schemesDebt schemesHybrid schemesSolution oriented schemesOther schemesSub-categories within each of these groups have been defined. For instance, equity schemes would include such categories as large-cap, multi-cap, mid-cap, etc. with clearly defined parameters for schemes in each category. Further, an AMC can have only one fund in a category, expect for categories such as thematic, sectoral, index funds, ETFs. These guidelines would result in a rationalisation of funds across categories.The standard definitions for each category would result in funds with uniform strategies being classified together, making evaluation and selection of funds easier. Although the large number of categories within equity (10 standard and 3 to 4 other categories) and debt (16 categories) might continue to pose challenges for investors to navigate.As a consequence of the above guidelines, AMCs would need to categorise their funds into defined sections and seek approval from the regulator prior to finalising the same.AMCs, particularly those running multiple funds with similar mandates, would either need to make changes to the investment strategies or mandates or merge them with other existing funds.Sebi requires AMCs to submit their fund categorisation and rationalisation proposals by the December 15, 2017. Once the regulator provides their view on the proposals, AMCs would need to implement required changes within three months.AMCs would be required to communicate any changes in fund attributes, mergers, etc. to investors within a stipulated period and typically in case of significant changes in attributes, exit options would be provided to investors.As an investor, it would be advisable to keep a track of any changes related to fund attributes, etc. announced by AMCs over the next few months.Significant changes in the investment strategy or mandate might result in a fund becoming unsuitable for one’s portfolio based on investment horizon, risk appetite or desired portfolio mix.For instance, a large cap fund being reclassified as a large and mid-cap fund would result in a change in the fund’s risk and return attributes.Going ahead, investors should evaluate a mutual fund scheme by comparing it with peers classified as per the Seni categorisation.Dhaval Kapadia, CFA, Director, Portfolio Specialist, Morningstar Investment Adviser India