Best Value For Your Money from RamaKrishnaVadlamudi: SEBI Categorization and Rationalization of Mutual Funds - vrk100

SEBI Categorization and Rationalization of Mutual Funds

(This is for information purposes only. This should not be construed as a recommendation or investment advice even though the author is a CFA Charterholder. Please consult your financial adviser before taking any investment decision. Safe to assume the author has a vested interest in stocks / investments discussed if any.)

In October 2017, India's capital market regulator Securities and Exchange Board of India (SEBI) categorized mutual fund schemes into six categories, like, equity schemes, debt schemes, hybrid schemes and so on -- with a view to providing clear distinction and uniformity, in terms of asset allocation and investment strategy, to mutual fund plans.

SEBI's broad idea is investors, while assessing various mutual fund plans, should be able to properly understand the plans in terms of similarity of plans and uniformity of their characteristics.

1. Major Changes by SEBI

The major changes started in October 2017 by SEBI had several follow-up norms and further changes. The article looks at these changes and discusses the broad contours of these changes in the past six years or so.

As part of the changes, SEBI unwittingly was forced to introduce another new type of equity category, namely, Flexi Cap funds in November of 2020 -- which was a result of unsavoury changes made to Multi Cap funds in September of 2020.

The author's real time views on 2020 multi cap fund changes were carried by Morningstar India, along with those of veteran fund managers, like, Sunil Singhania.

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Related blogs:

AMFI List of Market Cap: Categorization of Large-, Mid- and Small-Cap Stocks

SEBI's New Regulation on Multi Cap Funds and Market Behaviour

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2. Five Mutual Fund Groups

SEBI categorized all open-end mutual fund schemes into five broad groups. They are:

A. Equity schemes (11 schemes in total)

B. Debt schemes (16)

C. Hybrid schemes (6)

D. Solution-oriented Schemes (2)

E. Other schemes (2)

In case of equity schemes, mutual funds have to invest a certain percentage of stocks in the so-called large-, mid- and small-cap stocks as per the 'type of scheme,' as detailed in an earlier blog.

SEBI defined stocks based on their market capitalisation as follows:

1) large-cap stocks: 1st to 100th company in terms of full market capitalization

2) mid-cap stocks: 101st to 250th company in terms of full market capitalization

3) small-cap stocks: 251st company onwards in terms of full market capitalization

3. Equity schemes

The below table details equity fund categories, features of these categories and the percentage of stocks of total assets to be invested by each category. And it delineates what percentage of stocks to be invested in each category of stocks by market cap, namely, large-, mid- and small-cap stocks.

For example, a large cap fund has to invest at least 80 percent of total assets in large-cap stocks (as defined above). A large and mid cap fund has to invest at least 35 percent in large-cap stocks and 35 percent in the so-called mid-cap stocks.

An ELSS plan is an equity linked savings scheme, which provides tax benefits but comes with a lock-in period of three years. It has to invest at least 80 percent of total assets in stocks.

On 11Sep2020, SEBI changed the asset allocation of Multi Cap funds and made it mandatory for them to invest at least 25% of total assets in each category of large-, mid- and small-cap stocks; and in total they have to invest at least 75 percent of total assets in equity and equity related instruments.

A new equity mutual fund category, named Flexi Cap Fund, was introduced in November 2020 by SEBI in order to mollify mutual fund industry which was upset with the new SEBI norms on Multi Cap funds that were introduced on 11Sep2020 (only two days later SEBI was forced to issue a clarification to the Multi Cap category's new norms).

Flexi Cap funds have the agility to move across stocks, irrespective of their market capitalisation -- giving a high degree of operational flexibility to fund managers.

Because of the operational flexibility inherent in Flexi Cap category, several mutual funds moved, between December 2020 and March 2021, their existing multi cap funds to flexi cap category en masse, as allowed by SEBI norms (see additional notes below).