SEBI’s latest circular aimed to make MF industry more uniform

In its latest circular, SEBI has clarified on market capitalization norms for equity funds. Now the market capitalization for the previous six months would be considered for equity fund classification. This is followed by the earlier circular dated October 6, 2017, which proposed some sweeping changes for AMCs to make the life of investors of mutual fund easier. The proposed changes are expected to bring uniformity and standardization in different schemes offered by different fund houses.

According to earlier circular (dated October 6), the mutual fund schemes need to be classified into five broad categories namely equity schemes, debt schemes, hybrid schemes, solution-oriented schemes and other schemes. Solution-oriented schemes will comprise of retirement or children funds. Equity schemes will be further classified only into 10 sub-categories such as large, mid, small cap, multi-cap etc. Similarly, the debt schemes can be classified into 16 sub-categories, while hybrid funds can be further classified into six sub-categories. More importantly, only one scheme per category will be permitted by a fund house. Further, the fund needs to stick to their mandate.

For instance, if the mandate of a fund is to be large-cap oriented, it needs to invest a minimum 80 per cent in the top 100 stocks by market capitalisation, which is defined as large-cap stocks by that circular. Similarly, a mid-cap equity fund needs to invest a minimum of 65% of asset in mid-cap stocks, which are defined as stocks that rank between 100-250 in terms of market capitalization. From the 251^st rank onwards, companies will be classified as small-cap.

To comply with the circular, fund houses need to review their classification and submit their proposal to the SEBI within two months detailing their plans on merging, winding up or tweaking the ones that don’t fit in these categories. Once SEBI clears their proposal, they will have to carry out the necessary changes within three months.

Impact on Investors

These changes, if implemented with right spirit, will go a long way in making mutual fund as a preferred way of channelizing savings of retail investors. You can make a much more informed decision and will be more confident in what you are buying. This will help you to better plan your future and set aside your asset allocations, accordingly. For example, if an investor aged 35-45 years is investing in the small-cap fund, he is willing to take a risk with an expectation of good returns. Nonetheless, if the fund starts allocating more funds to large-cap, it may not solve the entire purpose of his investing.

Besides, it will help the investor compare funds between two different mutual fund houses. The current practice makes it a bit difficult because each fund house follows its own logic when it comes to defining market caps.

Impact on performance of funds

Performance of the fund may be impacted as currently, large-cap has the freedom to invest a portion of their portfolio in mid and small-cap stocks, which helps them generate alpha, which might not be possible once the new classification is implemented. Moreover, in order to fit into a particular category fund may need to do a lot of portfolio churning, which will impact the performance of funds. And this process of rebalancing of funds according to its mandate needs to be followed every six months, which again may impact its performance. 

Overall, we find the latest initiative taken by SEBI will help the mutual fund industry in India to grow faster and become more vibrant, although, there are short-term pains.