Oct 12, 2017 11:23 AM IST | Source:

New SEBI rule on MF re-categorisation to help investors, force AMCs to trim portfolio

The regulator’s objective behind the move is reduce confusion for mutual fund investors, and deter asset management companies (AMC) from coming out with overlapping products merely to boost their assets under management.

The Securities and Exchange Board of India’s rule asking mutual funds to re-categorise schemes based on investment strategy will help investors get a better idea of what they are buying into, feel industry observers. The regulator’s objective behind the move is reduce confusion for mutual fund investors, and deter asset management companies (AMC) from coming out with overlapping products merely to boost their assets under management.

AMCs charge fees on the assets managed, and so larger the assets under management, more will be the income. Over the years, this has led to AMCs launching a slew of schemes without much to distinguish them from the existing offerings in the portfolio.

While they would not want to say it publicly, many AMCs are unhappy with the new rule as the cap on one scheme per category will force them to merge many of their existing schemes.

“In general there is not much of a problem for mutual funds,” says Kaustubh Belapurkar, Director Fund Research at Morningstar India, a fund analytics company. “There will be little pain in reworking the portfolios but the overall result will be good for investors,” he says.

SEBI has been trying to get AMCs to merge schemes where there is not much difference in terms of the investment strategy as well as objective. The latest rule change should help accelerate the process.

“AMCs with too many schemes will have to do extensive rejigging but AMCs with limited number of schemes are better off,” said Jimmy Patel, Chief Executive Officer, Quantum Mutual Fund.

There could be some costs involved as well for mutual funds in merging the schemes as some investors may want to exit.

The new rule requires investment objective, investment strategy and benchmark of each scheme to be "modified to bring it in line with the categories of schemes mandated therein."

A change in “type of scheme” alone would not be considered as a change in fundamental attribute, but modification of investment objective and investment strategy entails a change in fundamental attributes requiring an exit option. Industry players say it remains to be seen as to who bears the costs of exit option, the scheme or the AMC. If the scheme bears the cost, this would be additional expense to the scheme, reducing the NAV for investors to that extent.

“It remains to be seen whether the additional costs for such changes will be borne by the investors in the scheme,” said a former SEBI official.

Some observers feel the revised rules may not speed up the consolidation of mutual fund schemes.

“If one sees from an MF perspective, then large fund houses may have to do minor realigning or tweaking but at the same time it gives mutual funds a legitimate reason for launching NFOs (new fund offers),” says Dhirendra Kumar, Chief Executive Officer, Value Research, a mutual fund research firm.

“At the same time, the categorisation means that investors will be able to compare the performance better than before,” he says.

SEBI has broadly divided mutual funds into five categories – equity funds, debt funds, hybrid funds and solution-oriented funds and other funds. Within equity funds, there can be 10 offerings– multi cap fund, large cap fund, large and mid cap fund, mid cap fund, small cap fund, dividend yield fund, value fund and contra fund, focussed fund, sectoral/thematic fund and ELSS. Fund houses have to fit in their schemes in any one of the prescribed categories.

Within the hybrid category, too, there can be multiple offerings-- conservative, balanced and aggressive--based on the equity component in the scheme. Domestic fund managers say that on the face of it, prescribing only five scheme categories makes it simple for a lay investor to make up his mind. At the same time, it also runs the risk of oversimplification, they claim.

Some industry observers feel there could be ambiguity about capital protection schemes.

In capital protection schemes, which have a mix of equity and debt, and are close-ended, the emphasis is on capital protection at maturity. The strategy is not tied to an allocation percentage, but rather flows from its asset structure depending upon maturity duration.

Fund officials on condition of anonymity said that the new sequel of capital protection proposals may either not find approval from SEBI after this October circular or that investment proposals of capital protection may run the risk of having to adopt one of the prescribed hybrid categories, thus deviating it from its original strategy. It remains to be seen if, in future, a capital protection scheme would be mis-sold as a simple hybrid category product, which it is not.

According to MF experts, the circular also requires the benchmark index of scheme performance to be modified to fit into one of the prescribed categories. The investment judgment of an investor on existing schemes is based on the scheme performance vis-a-vis its existing benchmark index. If benchmark is tweaked for existing schemes, scheme performance across the years will lose a meaningful comparison. This requirement would be better suited to new scheme proposals only.

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