The Changing MF Landscape And Its Impact On You

The entire ecosystem of mutual fund industry is set to change impacting each stakeholder. DSIJ deep dives to find the reasons for such changes and what should you be doing with your mutual fund investments.

Change is painful, but if you do not change, it could prove disastrous, if not fatal. The current tectonic shift happening in mutual fund industry is similar in nature and is going to be discomforting for many of us, including fund houses and investors. Nevertheless, in the long run, it will be beneficial for all the stakeholders of mutual fund industry and will lead to healthy increase in the size of the industry. Traditionally, most of the mutual fund investors looked at the past returns of funds to decide on the right kind of fund to invest in. Nonetheless, some of the discerning investors also looked at the category return and then they compared the top-rated funds on some of their statistical parameters to arrive at the fund they want to invest in. All the performance measures and statistical parameters to assess the fund’s ‘investability’ were calculated based on holdings of the funds and how they have performed in the past. 

Nevertheless, soon many of the investors will find it hard to do their research as we may see a change in the name of the funds, change in the holdings of the funds, their mandates and even some of the funds might get merged with other funds or some will just fold up. The reason for all these possible changes is to comply with one of the circulars issued by market regulator SEBI in the month of October 2017. According to the circular, all the Asset Management Companies (AMCs) need to categorise their schemes into a specific definition (Please see box: The Reset Button for Mutual Fund Industry). 

Earlier, many of the AMCs, if not all, launched various funds that were similar in nature and construct in almost every aspect, but with different names. For example, a fund house would have more than one fund in its stable, which primarily invested in large-cap stocks with different names. Just to give you a perspective, we analysed the data at the end of March 2018 from one of the popular website on mutual fund and we found that some of the fund houses have more than 10 funds in the large-cap category (See Table: Top fund houses with number of funds in different category) 

Even in the case of mid-cap category, there are more than five funds. Kaustubh Belapurkar, Director, Fund Research, Morningstar Investment Adviser India, explains the reason behind such a move and how it is going to help industry. “Prior to the categories being defined, each asset manager had their own category definitions, which resulted in varied fund mandates within the same category. For instance, managers had their own definitions for what constituted large, mid and small cap stocks. For example, one manager may define large-cap stocks as the top 100 stocks, while another may use a cut-off of, say, Rs 5 bn for large-cap stocks. Even categorisation of funds was different for each fund house. For example, one fund house may define their large cap fund as a fund holding at least 90% in large-cap stocks, while another may define the same as at least 75% in large-cap stocks. This resulted in fairly different mandates within funds from the so-called 'similar fund' categories. This could potentially lead to having fairly divergent returns within categories primarily due to certain type of holdings doing better than the others". 

Therefore, the scheme of a fund house may be true to level of their own definition of classification of stocks. But from other fund house’s definition of stocks, the same fund might not be true to its level. There were more than 1,800 primary schemes offered by these AMCs earlier, including debt funds. Instead of giving them more option, this would create confusion amongst investors. Therefore, any comparison of category of funds across fund houses may not give a correct picture. The different definition and categorisation by the mutual fund houses was done to beat the category and benchmark returns. However, for an investor, it was creating difficulty in selecting the right kind of funds that suited his risk-return profile. 

So, to clear this confusion and bring in more clarity and uniformity to the entire offerings of mutual fund houses, SEBI came out with the circular that will require all the fund houses to have only one scheme per category. Going one step ahead, SEBI has even defined the categories. It has broadly defined mutual funds schemes into five categories. They are equity, debt, hybrid, solution oriented and other schemes. Belapurkar further explains that with SEBI’s recategorisation exercise, there is a level playing field for all managers and funds will have uniform mandates within a category. Thus, going forward, it will be a true test of fund managers' skills and their alpha generation capability”.

The entire process 

To implement all these changes, all the fund houses were supposed to assess their offerings’ and come out with their proposal on how they intend to comply with the new circular. Within two months of the circular, the fund houses had to submit their proposals to the regulator. After the submission, SEBI would give its nod to start the process of transition. Most of the fund houses, at least those with smaller assets under management, have already got the approval for their proposed changes. They need to complete the entire transition within three months. Before that, they need to inform the existing unitholders about the changes, alteration in the mandate of the fund they have invested in and give them the exit option without the exit load. 

Where do we stand currently 

The entire process of rationalisation and categorisation was supposed to rejig the mutual fund industry inside out, with repercussions that could be felt in the equity markets. According to a report by a large foreign brokerage firm, the entire process of realignment of funds with the objective of conforming to the SEBI circular would have led to buying of around Rs 19,000 crore in mid-cap stocks. The basis of this report was the holdings of the equity funds at the end of October 2017 and the assumption that the fund houses will stick to the current level of categorisation. For example, a fund with a mandate of investing in mid-cap funds would now stick to guidelines issued by SEBI and have to align its portfolio along with new market-cap defined by AMFI. Hence, if it is short of mid-cap stocks, the fund may have to buy and that will boost demand for the mid-cap stocks. 

More than six months have elapsed since the circular was issued by SEBI. The mutual fund industry is coping up with the new directive. Only minor changes have occurred as only two per cent of the funds have undergone changes. However, most of these funds are from the debt category. The number of funds in the equity category has declined by six by the end of March 2018 and the irony is that it has gone up by 12 in case of the debt category. One of the reasons for such limited shake-up is due to the wide choices given by SEBI to change fund’s mandate that would easily avoid any merger or liquidation of the funds. For example, if a fund house has more than three funds in large-cap category, it can keep one as a large-cap and can covert the other two into sectoral funds, depending on the portfolio of the scheme. 

The recent changes are also a blessing in disguise for many small fund houses which did not have any funds in any particular category. Now, these fund houses can introduce funds into those categories and do not have to define the basket of stocks also. Everything is now laid down by SEBI. 

What should you be doing 

With all these changes, you might be worrying what will happen with your funds and, more importantly, what should be your strategy now. The analysis of all the approvals a fund house received from SEBI to realign its schemes to comply with its circular shows that no major change has been happening except for couple of funds. The current changes are not as drastic as was expected when the circular was issued. Belapurkar also shared his view on this and said “We do expect changes to happen in portfolios, but we don’t think they will be drastic for all funds. Many funds will only need to make changes at the margin in their portfolios to align themselves with their new categories”. He further elucidated, saying: “Overall, at an industry level, these changes will be carried out over the next three months, so the impact should be manageable.” 

Nevertheless, it will entail certain changes and, as an investor, you need to remain alert and informed about the changes. There are three things you should focus on, namely, your risk profile, return expectation and investment horizon. According to Belapurkar, “These factors decide the most suitable asset allocation for their portfolios.” Therefore, even if your fund is changing its name or construct, it does not mean that you should exit the fund. You should assess your investment objective and see if the current change in the fund will help you to achieve your goals. If the changes are minor, then you can continue with the fund, otherwise you can exit and invest in a fund that suits your risk-return profile and meets your asset allocation requirements. 

The Reset Button for Mutual Fund Industry 

Categorisation and rationalisation of MF schemes by SEBI: 

The SEBI’s primarily motto behind this is to reduce the confusion of investors. So, it has come out with a solution with this circular under which it has ordered fund houses to maintain one scheme under each category, due to which AMCs will have to align their basket of existing funds according to new classification. Different schemes should be distinct in nature in terms of investment strategy and asset allocation. The broad classification of fund categories are given below. 

Equity Schemes 
Debt schemes 
Hybrid Schemes 
Solution-oriented schemes 
Other schemes 

SEBI has finalised the 11 major categories under the equity schemes. But a mutual fund house has to choose between value or contra scheme, so one fund house can opt for 10 schemes among 11 hybrid schemes 

SEBI has finalised 7 categories under hybrid schemes. However, an AMC can only have 6 categories and it has to decide within balanced hybrid fund or aggressive hybrid fund. In the circular SEBI has put the arbitrage fund under the hybrid fund category Also, under solution-oriented schemes, debt schemes and other schemes, SEBI has mentioned norms regarding the investment strategies and lock-in periods. 

Also, to simplify the schemes and to ensure uniformity in equity universe, SEBI has also announced the classification of stocks under the large-cap, mid-cap and small-cap stocks as per the market capitalisation. The classification is as follows: 

Large-Cap- First 100 companies in terms of market capitalisation 
Mid-cap- From 101st to 250th in terms of full market capitalisation 
Small-cap- All companies from 251st company will be covered under small-cap category. 

AMFI, the industry body, will update the list of stocks in large-cap, mid-cap and small-cap half yearly in June and December. The list will be provided five days before the end of the six-month period and funds will have a month's time to realign their portfolios