SEBI categorization of mutual funds in India

SEBI’s contention has been, and rightly so, that this classification gives greater clarity to the
mutual fund investors about what is the investment portfolio that they are investing in.
May 17, 2018 11:49 IST | India Infoline News Service

The new mutual fund categorization norms announced by SEBI call for
reclassification of schemes by all the mutual funds. Before getting into the
nuances of the reclassification, let us understand the logic behind this move.
Indian mutual funds offered over 2,000 mutual fund schemes across 40 AMCs.
Each scheme had a direct plan and a normal plan and each plan had a dividend
option and a growth option. For a mutual fund investor, this was just too
confusing. Moreover, the larger AMCs with more than Rs.200,000cr in AUM
would have multiple equity schemes with different names but the same
structure. This made the choice tough for the mutual fund investor.
 How
and
why
of

reclassification

As shown in the classification chart, SEBI has defined 10 categories for equity
funds, 16 for debt funds, 6 for hybrid funds and 2 for special situation funds.
While hybrid funds combine equity and debt, the special situations funds offer
goal-based solutions for retirement planning and for creating a children’s fund.
Each AMC can only have 1 scheme under each of these 34 categories shown in
the chart above. However, there is a fifth category “Others”, which will consist
of all other funds like index funds, ETFs, gold funds, Fund of Funds etc. Funds
can have any number of schemes under this category. SEBI’s contention has
been, and rightly so, that this classification gives greater clarity to the mutual
fund investors about what is the investment portfolio that they are investing in.
The communication is much clearer to the investor and comparison across
funds becomes more meaningful. How does SEBI reclassification improve the
investor’s understanding of what they are getting into?

Greater clarity on equity funds classification

The new classification will call for a consolidation of funds and also change in
nomenclature. For example, the name of the fund will have to be determined
by the asset mix. A fund that has over 90% of its portfolio in index stocks will
be classified as an index fund. So, a diversified equity with over 90% exposure
to index stocks will now be classified as an index fund. An equity fund will be
given the tag of “large cap” or “mid cap” based on the proportion of respective
holdings.

SEBI has also clarified on the definition of large caps and mid caps. Instead of
going by absolute cut-offs, the listed companies will be ranked by market cap.
The top-100 will be large caps, the next 150 will be mid caps and the remaining
stocks will be small caps. This makes comparison simpler across fund
categories. SEBI has clearly defined themes like Value, Contra, Sectoral etc and
each AMC can only have one fund of each of these categories. For the investor
and for financial advisors, the job becomes more structured.

Debt funds will be about duration and asset quality

Debt fund categorization will now have to be done based on the duration of the
portfolio or the credit quality. On the basis of duration, you have a complete
range from overnight funds to 10-year funds. The other criterion for
classification is credit quality. You can have funds like credit funds, gilt funds,
corporate bond funds and dynamic funds where the name of the fund describes
its nature and objective clearly. While debt fund investors are normally the
savvy corporates and HNIs, financial advisors will be more confident
recommending debt funds to their retail investors.

Granular classification of hybrid funds

Here again SEBI has focused on removing the ambiguity. There is no confusion
over balanced funds and MIPs. The hybrid fund will either be an aggressive
hybrid fund or a conservative hybrid fund and the name will be enough to
indicate the mix of debt and equity. Cash-futures arbitrage funds will also be
classified as a hybrid fund only. This removes most of the grey areas
surrounding hybrid funds where the nature of the mix is critical and whether
the strategy is clearly defined as static or dynamic.

Reclassification is a step in the right direction

One can argue that post reclassification, the number of schemes has not
reduced substantially, but that is off the point. What matters is that a step has
been taken towards standardizing definitions, classifications and
nomenclatures. Small investors will now have much greater clarity when they
are investing in equity, debt or hybrid funds. Fund nomenclatures will actually
reflect what the fund composition is. For financial advisors, the task of tagging
funds to goals becomes a lot easier and even benchmarking becomes sharper.
This could also be a big boost for the Do it yourself (DIY) investor depending
largely on online and robo advisory. But above all, the mutual fund investor will
finally be on WYSIWYG (What you see is what you get) mode!