Fewer fund schemes good for retail investors

Once Sebi regulations are implemented, they will have to make changes in their portfolios

After nudging mutual fund houses to reduce the number of schemes for the past five-six years, the Securities and Exchange Board of India (Sebi) has finally taken the strong step of classifying all schemes under five broad categories. Every category has been further classified into 36  sub-categories. And fund houses can now have only one scheme per category. 

At present, 42 fund houses have  2,000-odd schemes. Of these, almost 800 are fixed maturity plans within the closed-end category, which will not be impacted by Sebi’s circular. But fund houses will have to take action in many other schemes within three months. 

All this is good news for retail mutual fund investor. Instead of having to select between one ‘large-cap’ and another ‘large-cap plus’ scheme from the same fund house with similar top holdings, he will now know that the fund house has only one large-cap scheme and the ‘large-cap plus’ is probably a large-and mid-cap scheme, and not another clone of the existing large-cap scheme. Says Nilesh Shah, managing director, Kotak Mutual Fund: “Sebi’s recent guidelines on consolidation and merger of mutual fund schemes is a welcome step from the investor point of view. In the maze of more than 2,000 schemes, an investor gets confused. In a simple category, like large-cap fund, he gets confused by a large number of categories. Some balanced funds have higher equity allocation while others have lower equity allocation. Then, there are mid-cap funds with large-cap stocks and some even have small-cap stocks. Consequently, he looks to invest, based on performance comparison without realising that he is comparing apple and oranges. Sebi’s move will reduce the clutter and make it simple to compare performance amid a level-playing field.”

Even the performance of funds might improve. Aashish P Sommaiyaa, managing director  and chief executive officer, Motilal Oswal Asset Management Company, says: “With only one fund allowed in each category, one can expect fund houses to focus all their attention on that fund’s performance.” 

It’s merger time: According to research by Clearfunds.com, a Sebi-registered investment advisor (RIA), there are around 850 open-end schemes, of which around 50 schemes may have to be merged. This will include many of the big schemes. For example, HDFC Top 200, HDFC Equity and HDFC Large Cap fund, with a mammoth combined asset size of Rs  35,491 crore (see table), may have to be merged. However, Shah is not too worried about the size. “A good fund manager will be able to manage funds irrespective of their size. Mutual funds are less than six per cent of the total market capitalisation and about 25 per cent of the size of foreign institutional investors. There is enough scope for investment,” adds Shah.

“Size could become an issue in the small and mid-cap categories,” says Vivek Agarwal, co-founder and chief investment officer, Upwardly.in, a tech-based wealth advisory and investment platform.

Given all the action that is likely in the next few months, expect letters and emails saying that your existing scheme is being merged with another — mostly likely a bigger or better-performing one. “Investors should be cognizant of the changes taking place. They should check the fund they are in after consolidation and review whether it suits their portfolio requirement,” says Sommaiyaa. 

There is good news, however. Says Rajiv Shastri, MD and CEO, Peerless Funds Management Company: “The merger of funds will not lead to any tax liability for investors.” This provision was introduced in Budget 2017-18.

Outperformance may become more difficult: The Sebi circular clearly defines which stocks equity funds must invest in and their percentage exposure to these stocks. Large-cap funds, for instance, must invest in 1-100 stocks by market cap and must have a minimum 80 per cent exposure to large caps. In the past, many large-cap fund managers would take as much as 30 per cent or more exposure to mid-caps to boost performance. “After rationalisation of scheme categories and also with the introduction of total return index, more large-cap funds could find it difficult to outperform their benchmarks, especially if they have a high expense ratio. This could expedite the shift towards index funds and exchange traded funds  within this category,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors. Kunal Bajaj, founder and CEO, Clearfunds.com, expects more index funds and ETF choices to become available, as there are no regulatory limits on the number of schemes tracking different indices. Focused funds, which can invest in up to 30 stocks only, may find the going difficult with an increase in asset size. As fund size grows, they will have to become large-cap oriented, and lose the flexibility to move across market caps. 

Better goal synchronisation in hybrid and debt category: Hybrid funds, which have witnessed massive inflows in recent times, have been demarcated into conservative, balanced and aggressive categories. “This will provide investors a clear idea of the equity exposure and risk level of these funds,” says Agarwal. 

Segregating dynamic asset allocation and multi-asset allocation funds into separate categories is another positive. Earlier, they were often clubbed within the balanced category, whereas their mandates are quite different. These funds are useful for do-it-yourself investors by distributing their investments across asset classes and rebalancing them. 

In the fixed-income category, demarcation of fund categories by duration will allow investors to pick funds based on their investment horizon and risk appetite. Fund managers who used risky strategies (such as raising duration to outperform in a falling rate scenario) will not be able to do so anymore. “Separation of credit risk funds from corporate bond funds will prevent investors, who are unaware of the higher risk in the former, from investing in them,” says Dhawan. The creation of a 10-year constant duration gilt fund category will allow investors to circumvent fund manager risk — the risk that he gets his duration calls wrong in longer-term gilts.

Clear categorisation will also lead to all fund houses and fund rating agencies using the same categories, and having the same funds within those categories. “It will lead to convergence in peer or comparison sets,” says Prashant Joshi, head-product development, Tata Asset Management.

Fund houses may, however, begin to launch more closed-end funds, which are outside the purview of this circular. These funds carry the risk that investors don’t have any control over how the markets are performing when the fund’s tenure ends. Hence, they could end up with poor returns despite having invested for a significant amount of time.