1. Why are the mutual funds being recategorized?
Recently, SEBI came up with a regulation on categorization and rationalization of mutual fund schemes. It is an effort to bring about uniformity in the functioning of asset management companies (AMCs) and to standardize attributes of mutual fund schemes across specific categories. Under this regulation, the fund houses need to define their mutual fund schemes clearly. The product offerings need to look different from each other in terms of core characteristics like investment objective and asset allocation. This would help a mutual fund investor to examine a mutual fund scheme properly before finalizing the decision to invest in it.
SEBI has specified 36 categories of mutual fund schemes in total. As per the new rules, the AMCs will not be allowed to offer two schemes under different names with identical investment mandates. One category of mutual fund will be permitted to sell only one mutual fund scheme. As a result of this mandate, the fund houses are now realigning their schemes and portfolio to classify them under the newly formed categories.
2. How are mutual funds being recategorized?
As a mutual fund investor, you need to understand the latest categorization of mutual funds in order to take informed decisions. SEBI has brought about the following changes as regards the categorization:
a. Classification of Schemes
Prior to the latest regulation, there was lack of clarity regarding the what constituted a specific category of mutual fund. There were thin lines of differentiation especially as regards large-cap or multi-cap. The asset allocation and the overall risk profile of the fund did not follow the investment mandate. After the recategorization, SEBI has specified the entire universe of mutual funds to be classified under these 5 categories i.e. Equity, Debt, hybrid, Solution oriented and others.
b. Naming of Schemes
The new regulation calls for a renaming of the schemes to clearly indicate the level of risk involved in the investment. Now, the fund houses would have to drop fancy names from their mutual fund offering to reflect the true picture. Earlier, the mutual fund scheme name consisted of words like “opportunities”, “advantage” and “prudence” to make it look seemingly lucrative. However, the investor was unable to gauge the inherent risk while making an investment. After passing of the regulation, many scheme names have been changed in order to enhance existing disclosure.
c. Introduction of Lock-in Period
SEBI has introduced a lock-in period in case of Solution Oriented Schemes like retirement fund and children’s fund. However, the existing investors of the scheme need not worry about it because the said lock-in period would not be applicable to them. Additionally, the same rule applies to existing registered systematic investment plans (SIPs) and incoming systematic transfer plans (STPs).
d. Modification of scheme attributes
Apart from the category and name of the scheme, the fund house needs to modify other aspects of the scheme with it to bring it in line with the said regulation. These include the investment mandate, the benchmark and the investment strategy of each mutual fund scheme.
3. What changes have been made in equity funds?
There were a lot of irregularities in equity funds as regards their asset allocation and definitions. For instance, a large-cap equity fund would be substantially invested in small-cap stocks in order to generate a higher rate of return. On one hand, investors seemed satisfied because the returns were in line with their expectations. However, they were unaware of long-term implications of such digressions from the investment mandate of the fund. In the long-run, a slump would have washed out all the temporary gains in the fund value which were made during the period of a market rally.
The following changes have been made with respect to equity funds:
a. Changes in the Definitions
In an attempt to ensure standardization, the definitions of large-caps, mid-caps, and small-caps have been modified. After implementation of the regulation, large-cap stocks would be the top 100 companies of the underlying benchmark in terms of full market capitalization. Mid-caps would be companies ranking from 101st to 250th and small-caps would be companies ranking from 251st onwards in terms of full market capitalization.
b. Selection of Stocks
Mutual fund houses would have to pick stocks from the list which would be prepared by the AMFI. It would upload the list on its website and update it after every six months according to the data available in June and December.
c. Portfolio Rebalancing
Once the AMFI updates the list of stocks on its websites, the fund houses would be rebalancing their portfolio to reflect the latest changes. They will be allowed a period of one month to complete the rebalancing after the date of publication of changes on the website.
4. What are the New Categories of Mutual Fund Schemes?
It would be highly insightful to know the latest categories and their further classification as per the regulations launched by SEBI.
a. Equity Funds
The equity funds have been further divided into following 10 sub-categories i.e. large-cap fund, large & mid-cap fund, mid-cap fund, a small-cap fund, multi-cap fund, dividend yield fund, value fund, contra fund, focussed fund, sectoral/thematic fund and ELSS.
b. Debt Funds
The debt funds have been further divided into following 16 sub-categories i.e. overnight fund, liquid fund, ultra-short duration fund, low duration fund, money market fund, short duration fund, medium duration fund, medium to long duration fund, long duration fund, dynamic bond fund, corporate bond fund, credit risk fund, banking & PSU fund, Gilt Fund, Gilt fund with 10 year constant duration and floater fund.
c. Hybrid Funds
The hybrid funds have been further divided into following 6 sub-categories i.e. conservative hybrid fund, balanced hybrid fund, aggressive hybrid fund, balanced advantage fund, multi-asset allocation fund, arbitrage fund and equity savings fund.
d. Solution Oriented Funds
The solution-oriented funds have been further divided into following 2 sub-categories i.e. retirement fund and children’s fund. These funds will have a lock-in period of at least 5 years.
e. Other Funds
5. Where are these new norms applicable?
SEBI has identified the specific circumstances wherein these new norms are going to be applied. Let us see the list of eligible schemes:
a. All the open-ended schemes of all Mutual Funds which are existing at present.
b. All the open-ended schemes for which SEBI has issued final recommendation but which are yet to be implemented by the fund house.
c. All the open-ended schemes in respect of which the fund houses have filed a draft of scheme documents with SEBI as on date.
d. All the open-ended schemes for which the fund house is going to file a draft of the scheme document.