Fund recategorisation: What investors must do

By Morningstar |  14-05-18 | 

Scheme mergers are not something of a novelty in this industry. The past is cluttered with numerous examples due to one fund house acquiring the schemes another, or non-performing/ smaller funds being merged with another.

So why is it causing a flutter among investors now?

Because the current range of scheme mergers is taking place across the entire industry and is an offshoot of a turnaround effort by the regulator.

The Securities and Exchange Board of India, or SEBI, has called for the rationalization of mutual fund schemes and defined various categories of funds, along with the scheme characteristics for each fund category. The list of categories are:

  • Equity (10 sub categories)
  • Debt (16 sub categories)
  • Hybrid (6 sub categories)
  • Solution-oriented (2 sub categories)
  • Others which includes index funds, Exchange Traded Funds and Fund of Funds (2 sub categories)

To view the entire list of categories and sub-categories and their relevant definitions, take a look at the SEBI circular.

SEBI has also mandated that each fund house can have ONLY one scheme in each category. So only one large-cap fund, only on tax-saving fund, and so on and so forth; the exception being sector funds, ETFs and FoFs.

Once such a scheme has been pegged to a category, it has to stay within the boundaries of that category. So a large-cap fund cannot change its complexion to a multi-cap one when the market is not favouring larger fare. In other words, the fund manager needs complete adherence to the fund’s mandate. And yes, SEBI sets the definition for each category taking out the ambiguity and flexibility on the fund manager’s part. This is an extremely positive move. Since the investing universe is now defined more sharply, there is more clarity in decoding a fund manager’s performance.

While the fund industry groaned collectively at the colossal task facing them, it turned out to be an “OMG!” moment for financial advisers and investors once the implication on their portfolios hit them. If a fund was selected for its specific mandate and was a winner simply for the strategy from which it operated under, a change in either would definitely necessitate a relook.

How Morningstar is proceeding

Managers have made their categorization lists public and are now in the process of aligning their portfolios with the revised mandates. We expect this exercise to be completed by the end of June 2018.

The fund research team is taking a fresh look at the funds in light of the revised mandates announced by the fund houses. But it does not stop there. To gain greater depth of understanding, we shall be visiting the AMCs to gain a perspective from the fund managers on how they intend to run their respective fund within the confines of the revised mandate. This is particularly true for categories that allow fairly broad mandates such as Multicap, Dynamic Bond and Dynamic Asset Allocation. For example, a large-cap re-classified as a multi-cap fund doesn’t necessarily mean a significant move away from the previous mandate if the manager continues to run it with a large-cap bias.

If there is a dramatic change in mandate, the historical returns of the fund become irrelevant.  In such cases, we have the option to suspend the rating on the fund if deemed appropriate and only consider it once it completes 3 years under the new mandate.

How you, as an investor, should proceed

1. Revisit your portfolio.

You will have to take a fresh look at your portfolio. While you will have to revisit the funds in your portfolio, don’t be in a tearing hurry to execute changes. In haste, you could make the wrong decisions.

2. Check whether the change is cosmetic or goes much deeper.

Funds have to offer names that reflect the true nature of the portfolio. Words like “opportunities”, “advantage” and “prudence” could be misleading. So many schemes will undergo a change in names.

For instance, UTI SPrEAD Fund (Spread between Prices of Equity And Derivative) will be renamed to UTI Arbitrage Fund. Franklin India Prima Plus will be renamed Franklin India Equity Fund. SBI Emerging Businesses Fund will now be SBI Focused Equity Fund which will invest in maximum 30 stocks across the multi-cap space. ICICI Dynamic Plan will be ICICI Prudential Multi-Asset Fund which will invest in multiple assets like equity, debt and gold.

Then there will be scheme mergers. The AMC will try their best to ensure that a union of schemes ensures finding suitable matches. But investors shouldn’t simply accept that fate and must do the same due diligence had they been a new investor.

For instance, HDFC Prudence and HDFC Growth will be merged to form a new entity - HDFC Balanced Advantage Fund. Investors in HDFC Growth will see fundamental attribute changes in their fund’s investment style.

3. Take a holistic view.

Even post a change in mandate, you may still approve of the scheme. But view it now in conjunction with your entire portfolio. For instance, if you had just one large-cap fund in your portfolio and it has been reclassified as a multi-cap fund, you may want to see how it fits in with your other investments. Are you comfortable with no large-cap fund? Do you have too many multi-cap funds?

Amalaraj Marian of The Investquotient Financial Services, is keeping this in mind where his clients are concerned: “A few funds have seen drastic changes in their fund mandates. If these funds still suit investors’ goals we will recommend that they continue with their systematic investment plans.”

Even if you do decide to terminate your SIP in a fund, don’t be hurry to sell off the units accumulated. Keep the tax impact in mind.

Ketan Nanivadekar of Smart Money Financial Services also points to the need of making personalized calls and avoiding blanket opinions. “We will take a call after all the changes are done and look at each portfolio to see if it has to be tweaked, taking into account the tax implications,” he rightly says.  “The review has to be done based on each client’s risk profile and the fund’s new avatar.”

Don’t view any fund in isolation. Make every decision keeping the rest of your portfolio in mind.

Add a Comment
Please login or register to post a comment.
SV Prasad
May 15 2018 02:06 PM
Post SEBI new fund classification, readers will be able to apply and perceive a more enriching contrast of funds if they are presented with a tabulated or matrix form of representation of major fund attributes like asset / market cap mix i.e., large mid or small cap as defined in SEBI circular, (or duration mix in case of predominantly debt oriented funds) , average market cap / maturity, major sector exposure changes etc., providing the actual data or picture before the SEBI classification and the data on an ongoing basis after the categorization (shown along with old and new fund names if any). This comparison should be run and reflected at least for next three years or for a period till the risk-return characteristics of funds stabilize in their new categories. This is a real need of the hour for serious investors because, as time progresses after implementation of new SEBI category, the past risk-return data will undergo a lot of changes and reveal a distorted picture of trailing data for most of the funds where asset mix has undergone a significant change. This phenomena will persist till such time the funds stabilize their risk-return characteristics in their new categories and even your star ratings may have to undergo a lot of changes.

I feel SEBI new fund classification is an opportune time for Morningstar India to transform itself as a first point of connect for all MF and personal finance enthusiasts, investors and investment advisors, by presenting more readily analytical, contrasting and actionable data without involving elaborate numbers or data interpretation. Further, without drastically revamping your portfolio manager which is neither understood nor used by many, stickiness of readers and their constant loyalty may not be possible in view of superior free of cost alternatives and tools available online attracting a lot of page views and emerged as single point source for all the fund investor needs, education and analysis.
Mutual Fund Tools