Categorization and Rationalization of Mutual Funds



At the end of 2017, the Securities and Exchange Board of India (SEBI) brought in some changes in the composition, classification and characteristics of Mutual Funds vide two circulars titled Categorization and Rationalization of Mutual Funds, first, Circular SEBI/HO/IMD/DF3/CIR/P/114 dated 6th October 2017 and, second, SEBI circular SEBI/HO/IMD/DF3/CIR/P/26 dated 4th December 2017, which to an extent modified the previous circular. Several Asset Management Companies (AMC) have come out with the circular compliant changes, including change of names and the changes in Base Total Expense Ratio (TER), an exercise, likely to be completed by 30th June 2018.


Several AMCs had different schemes causing overlap of strategies, besides there being no uniformity in the norms defining these existing categories, this is what the circulars aimed to do away with. So far, there were emerging mutual fund schemes which had their respective novel strategies, such as, multi-cap, Flexi-cap, etc. The objective of this move is to create uniformity in the characteristics of similar schemes, enhancement of transparency and ensuring that underlying investment objective is reflected in the fund schemes and finally, to offer flexibility to investors in the nature of investments and risk exposure. In view of this, we may see clearly distinct categories being offered by fund houses.


These norms are applicable to all open-ended schemes of existing mutual funds, all such schemes for which SEBI has issued final recommendation but are yet to be implemented, all open ended-schemes in respect of which draft documents have been filed and for which drafts of the scheme are yet to be filed.


Five mutual fund categories have been recognized and these are, firstly, Equity Schemes, which will predominantly invest in Equity and Equity related instruments; Secondly, Debt Schemes, which will predominantly invest in debt instruments; thirdly, Hybrid Schemes, which will invest in a mix of equity, debt and other instruments; fourthly, Solution Oriented Schemes, such as retirement/children savings schemes (with lock-in periods of prescribed five years) and fifthly, Other schemes which will include ETFs, Fund-of-Funds and Index Funds.


The circular recognizes ten sub-categories of Equity Schemes. Schemes wherein 65% of total assets are invested in equity and equity-related instruments (across large-cap, mid-cap and small-cap stocks) shall be Multi-Cap Funds. Top 100 companies of the underlying benchmark would be a Large Cap Fund, whereas, a Large and Mid-Cap Fund is recognized has invested a minimum of 35% total assets in equity related instruments of large and mid-cap stocks respectively. A Mid Cap Fund, on the other hand, will be 101 to 250th companies. Similarly, a Small Cap Fund will require 65% of total assets invested in small cap companies. A Dividend Yield Fund shall require a minimum investment of 65% in equity, predominantly investing in dividend-yielding stocks. A Value Fund should follow a value investment strategy, investing a minimum of 65% of total assets in equity and related instruments. A Contrarian Fund has been recognized, which should follow a contrarian investment strategy while maintaining a minimum 65% investment in equity and related instruments. A Focused Fund shall focus on the number of stocks (max. 30) with similar minimum requirements. A Sectoral Thematic Fund shall have a minimum investment of 80% in equity and equity-related instruments of a particular sector/particular theme. Finally, ELSS requiring a minimum of 80% invested in accordance with the Equity Linked Saving Scheme, 2005.


Sixteen sub-categories of debt schemes are recognized. An Overnight Fund invests in overnight securities with a day’s maturity. A Liquid Fund invests in Debt and Money market security with 91 day maturity. An Ultra Short Duration Fund invests in debt & money market instruments such that the Macaulay duration is between three to six months, whereas in Low Duration Fund, the portfolio shall have duration of six to nine months. A Money Market Fund invests in instruments having a maturity of up to one year. Short Duration, Medium Duration, Medium to Long Duration Fund and Long Duration Funds shall invest in Debt and Money Market instruments such that the Macaulay duration of the portfolio is between one to three years, three to four years, four to seven years and greater than seven years. A Dynamic Bond would be one which invests across duration. Corporate Bond Fund has to have a minimum investment of 80% in Corporate Bonds whereas Credit Risk Fund has to have a minimum of 65% investment in Corporate Bonds. A Banking and PSU Fund shall invest a minimum 80% in debt instruments of banks, PSUs and public financial institutions. Gilt Fund will hold at least 80% investment in Gsecs. A Gilt Fund with 10-year duration is also recognized. Finally, Floater Fund must have at least 65% of total assets invested in floating rate instruments.


Six Hybrid Schemes are recognized such as Conservative Hybrid Fund investing predominantly in debt instruments, Balanced and Aggressive Hybrid Fund investing in equity and debt instruments and equity respectively, Dynamic Asset Allocation or Balanced Advantage, Multi-Asset Allocation investing in three different asset classes, Arbitrage Fund investing in arbitrage opportunities, Equity Savings investing in equity arbitrage debt.


The outcome of this restructuring process could have an impact on ratings of the Funds as where the change is major, historical returns of the fund will become irrelevant. The result is also going to rid of the deceptive terms such as Opportunities and Prudence in Fund names. Funds are to include investment mandate, benchmark rules have been strengthened and investment strategy disclosures of each fund are made robust.


This move is likely to ease the comparison of mutual fund schemes for investors. Even though most AMCs are permitting shuffles without exit load, investors might have to bear tax burdens. Besides, the fund managers may have to reshuffle scheme portfolios every six months, which will increase the costs and impact returns. In another compliance, every six months, fund managers are required to reshuffle portfolios based on investment categorization (large, mid and small) published by the Association of Mutual Funds in India.

All in all, this is a positive attempt and the results may be evident in the latter leg of 2018.

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