Categorisation and Rationalisation of Mutual Fund Scheme

Under the recent Categorisation and Rationalisation of Mutual Fund Scheme initiative of SEBI, mutual funds schemes are undergoing renaming, modification of investment mandates and mergers.

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.    

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:

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.

 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.  

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).

 Modification of scheme attribute

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.  

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:  

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.

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.  

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.    

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.  

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.

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.  

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.  

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.

Other Funds

The other funds have been further divided into following 2 sub-categories i.e. index funds and fund of funds.  

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:  

• All the open-ended schemes of all Mutual Funds which are existing at present.
• All the open-ended schemes for which SEBI has issued final recommendation but which are yet to be implemented by the fund house.
• All the open-ended schemes in respect of which the fund houses have filed a draft of scheme documents with SEBI as on date.
• All the open-ended schemes for which the fund house is going to file a draft of the scheme document.  

Frequently Asked Questions

As a tax-paying citizen, Section 80C of the Indian Tax Act allows you some breather – a deduction of up to 150,000 from your total annual income.

What are the different types of mutual funds?

You may classify mutual funds into open-end and closed-end funds. An open-end fund does not have a fixed maturity period. You may redeem the units at any time. Closed-end funds have a fixed maturity period.

You may invest in these funds during the initial period called the New Fund Offer. You can redeem your investment on the maturity date. However, closed-end funds are listed on the stock exchange and you may redeem units before the maturity date.

Mutual funds may invest in equity and equity-related instruments, debt or a mix of both. You can broadly classify mutual funds into equity funds, debt funds and hybrid funds.

Equity funds: Equity funds invest at least 65% of the total assets in equity and equity-related instruments. It may invest the remaining corpus in debt and money market instruments.

Debt funds: Debt funds invest the bulk of the corpus in fixed income instruments such as bonds, government securities and money market instruments such as treasury bills, commercial paper and certificates of deposit.

Hybrid funds: Hybrid funds put money in more than one asset class. It may be a combination of equity, debt and even a small proportion in gold. Hybrid funds are of different types such as aggressive hybrid funds, conservative hybrid funds, dynamic asset allocation or balanced advantage fund, equity savings fund, multi-asset allocation fund and balanced hybrid funds.

What are the different types of mutual funds in India?

SEBI had announced the re-categorisation of mutual fund schemes on October 6, 2017. It was done to bring uniformity as mutual fund houses had launched several mutual fund schemes. You may find investing in mutual funds quite easy after this move, as investors put money in mutual fund schemes that match their investment objectives and risk tolerance. Investors used to struggle to select the right mutual fund as AMCs had launched a plethora of similar mutual fund schemes.

SEBI had classified mutual funds into the following categories:

A. Equity Funds:
SEBI has categorised equity funds into eleven broad categories

Large Cap Fund: It invests at least 80% of the total assets in equity and equity-related instruments of large-cap companies.

Large & Mid Cap Fund: It invests 35% of the total assets in equity and equity-related instruments of large-cap companies. It also invests 35% of total assets in equity and equity-related instruments of mid-cap firms.

Mid Cap Fund: It invests at least 65% of the total assets in equity and equity-related instruments of mid-cap companies.

Small Cap Fund: It invests at least 65% of the total assets in equity and equity-related instruments of small-cap companies.

Multi Cap Fund: It invests a minimum of 65% of the total assets in equity and equity-related instruments.

Dividend Yield Fund: It invests mainly in dividend-yielding stocks and has a minimum of 65% of the total assets in equity.

Value Fund: It follows a value investment strategy and has at least 65% of the total assets in equity.

Contra Fund: It follows a contrarian investment strategy and has at least 65% of total assets in equity and equity-related instruments.

Focused Fund: It focuses on a maximum of 30 stocks. It has at least 65% of total assets in equity and equity-related instruments.

Sectoral/Thematic Fund: It invests a minimum of 80% of total assets in equity and equity-related instruments of a particular sector or a particular theme.

ELSS: It invests a minimum of 80% of total assets in equity and equity-related instruments (In accordance with Equity Linked Saving Scheme, 2005 notified by the Ministry of Finance).

B. Debt Funds
SEBI has categorised debt funds into sixteen broad categories.
Overnight Fund: It invests in overnight securities with maturity of one day.

Liquid Fund: It invests in debt and money market securities with a maturity of up to 91 days.

Ultra Short Duration Fund: It invests in debt and money market instruments where the Macaulay duration of the portfolio is between three months to six months.

Low Duration Fund: It invests in debt and money market instruments where the Macaulay duration of the portfolio is between six months to twelve months.

Money Market Fund: It invests in money market instruments with a maturity of up to one year.

Short Duration Fund: It invests in debt and money market instruments where the Macaulay duration of the portfolio is between one year to three years.

Medium Duration Fund: It invests in debt and money market instruments where the Macaulay duration of the portfolio is between three years to four years.

Medium to Long Duration Fund: It invests in debt and money market instruments where the Macaulay duration of the portfolio is between four years to seven years.

Long Duration Fund: It invests in debt and money market instruments where the Macaulay duration of the portfolio is above seven years.

Dynamic Fund: It invests across duration.

Corporate Bond Fund: It invests at least 80% of the total assets in corporate bonds of the highest rating.

Credit Risk Fund: t invests at least 65% of total assets in corporate bonds (Investment in below rated highest instruments).

Banking and PSU Fund: It invests a minimum of 80% of total assets in debt instruments of banks, PSUs and Public Financial Institutions.

Gilt Fund: It invests a minimum of 80% of total assets in Gsecs across maturity.

Gilt Fund with 10-year constant duration: It invests a minimum of 80% of total assets in GSecs where the Macaulay duration of the portfolio is ten years.

Floater Fund: It invests a minimum of 65% of total assets in floating rate instruments.

C. Hybrid Funds
SEBI has categorised hybrid funds into seven broad categories.

Conservative Hybrid Fund: It invests between 10% and 25% of the total assets in equity and equity-related instruments. It invests between 75% to 90% of the total assets in debt instruments.

Balanced Hybrid Fund: It invests between 40% and 60% of the total assets in equity and equity-related instruments. It invests between 40% to 60% of the total assets in debt instruments. No arbitrage is allowed in this scheme.

Aggressive Hybrid Fund: It invests between 65% and 80% of the total assets in equity and equity-related instruments. It invests between 20% to 35% of the total assets in debt instruments.

Dynamic Asset Allocation or Balanced Advantage: It invests in equity or debt that is managed dynamically.

Multi-Asset Allocation: It invests in a minimum of three asset classes with an allocation of at least 10% each in all three asset classes.

Arbitrage Fund: It invests a minimum of 65% of total assets in equity and equity-related instruments. The scheme follows an arbitrage strategy.

Equity Savings: It invests a minimum of 65% of total assets in equity and equity-related instruments. It invests a minimum of 10% of total assets in debt instruments. The minimum hedged and unhedged would be stated in the SID.

Mutual Funds may offer either an aggressive hybrid fund or balanced fund. Foreign securities would not be treated as a separate asset class.

D. Solution-oriented schemes
Retirement Fund: You may fund these schemes having a lock-in of at least five years or till the retirement age, whichever is earlier.

Children’s Fund: The scheme would have a lock-in of at least five years or till the child attains majority age whichever comes earlier.

E. Other Schemes
Index Funds/ETFs: It should invest at least 95% of total assets in securities of a particular index.

FoFs (Domestic/Overseas): It invests a minimum of 95% of total assets in the underlying fund.