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New Categorization and Rationalization of Mutual Fund Schemes


New Categorization and Rationalization of Mutual Fund Schemes

mutual fund scemesThe market regulator SEBI has come up with a new system for mutual fund classification. The new system aims to bring uniformity to the mutual fund schemes launched by different fund houses, thus facilitating scheme comparison across fund houses.

Based on the categories, mutual funds will be forced to either merge, wind down or change the fundamental characteristics of a particular scheme. This move could have short or long term impacts on your investment portfolio depending on the schemes you have currently invested into as your existing mutual funds may become conservative or more aggressive and risky.

 

As per the new classification, all open-ended mutual fund schemes will be placed under the following categories:

·       Equity

·       Debt

·       Hybrid

·       Solution-oriented

·       Others (index funds/ETFs/fund of funds)

 

Only one scheme per category would be permitted per fund house except index funds/ETFs, fund of funds and sectoral/thematic funds.

 

However, each of these categories will have sub categories:

·       Equity will have 10 sub classifications

·       Debt will have 16

·       Hybrid will have 6

·       Solution Oriented will have 2

·       Other will have 2 sub classifications.

 

That is a grand total of 36 classifications an investor can choose from.

As such, these new classifications will have varying impact on existing funds and consecutively on investor’s portfolio. Such impacts could include:

·       Schemes will be forced to stick to their mandate: Funds often change their investing style based on market conditions. For example, a large cap fund may have sizeable mid cap exposure because its chasing higher alpha. But now, any drastic change will force the scheme to change its characteristics resulting in the same being communicated to the investors. So now the investor will not have to worry about the fund becoming something it originally was not set out to do.

·       Like for Like Comparison: As AMCs will have one scheme per category, it will be easier for the investor to compare the options available. All schemes of different AMCs of a category will have similar styles and characteristics, which will result in a “apples to apples” comparison.

·       Better choice by fewer options: With AMCs forced to ensure one scheme per category and fund labelling to be made in line with investment strategy, options will become lesser which should result in investors being more aware of their choice.

·       Need for review in the short term: With the latest mandates, one can expect a short period of fund houses realigning their products. As such, many schemes may end up being quite different than what they originally were. Therefore, investors may need to keep a thorough eye on their funds to watch out for any changes that may occur and act accordingly.

·       Possibility of reduction in performance: Like mentioned above, funds often change their investing styles to generate significant alpha. But after these regulations, alpha creation may be more difficult as the universe of stocks will be same for all schemes in a category. Furthermore, as per the latest mandate, if a fund wants to be categorized say as a large cap, it will have to invest only stocks defined as large cap as per regulations. So in the short term it may have to sell or buy some stocks which could have an impact on cost that would be borne by the investor. Also, as regulations would demand funds to rebalance their stocks as per the semi – annual publications of AMFI which enlist large, mid and small cap stocks, it may result in forced selling to accommodate any change in status of a stock, resulting in a possible negative impact on the performance of the fund.

Overall, while there may be short term practical hurdles for both investors and fund houses alike while adjusting to the new mandates, the general consensus has been that this move is a positive step taken by the regulators in the right direction as it will bring reliability and simplicity to investors. For any investor, it would be prudent now to get professional advice on how such changes may impact their own portfolios.

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