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.
(blog continues below)
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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
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).
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4. Debt schemes
For example, a low duration fund has to invest in debt and money market instruments, with a portfolio Macaulay Duration of between six months and 12 months; while a dynamic bond fund can invest in debt instruments irrespective of the duration.
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The following table provides features of the remaining debt schemes -- providing details of their features, the minimum investment they have to make in sovereign / corporate bonds and what percentage of total assets to invest.
For example, a credit risk fund has to invest at least 65 percent of total assets in AA and below rated corporate bonds (excluding AA+ rated bonds); while a gilt fund has to invest a minimum of 80 percent in sovereign bonds, namely, G-Secs or government securities.
Please click on the image to view better >
5. Hybrid schemes
For example, a conservative hybrid fund has to invest a minimum of between 75 and 90 percent in debt instruments and a minimum of between 10 and 25 percent in stocks.
Please click on the image to view better >
6. Solution-oriented and other schemes
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7. Summary
One unintended consequence of SEBI's 2017 changes to categories of mutual funds is fund managers are forced to churn their portfolios more often in order to adhere to SEBI's norms on categorization and rationalization of mutual funds.
More churn or higher portfolio turnover means more profits for brokers, resulting in lower returns for unitholders of mutual funds.
The 2017 categorization norms have taken away the freedom of money managers to manage the funds and the capital market regulator's back-seat driving has constrained the fund managers.
The original objectives of SEBI's categorization of schemes have, so far, not been realised. Asset management companies (AMCs) still are able to slice and dice the markets and indulge in launching a variety of mutual fund schemes as part of their asset gathering efforts.
As the number of equity MF category is limited to eleven only, the AMCs have been increasingly launching more and more schemes under the thematic / sectoral fund category.
During the period Apr2019 and Jan2024, number of thematic / sectoral funds rose from 91 to 150, with their assets rising by 337 percent to Rs 2.71 lakh crore as at the end of Jan2024 (see Additional Note 2 below).
Most of the investors still base their investment decisions (buying and selling of mutual funds) based on the past returns, chasing whatever hot fund/funds are the current flavour of the markets.
The introduction of a new equity fund category, namely Flexi Cap funds in November 2020, provided another window for AMCs to gather more assets.
The true colours of AMCs have not changed since the introduction of SEBI's norms on mutual fund categories, while the confusion for investors continues without any respite.
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Additional Notes and Data:
1. Flexi Cap funds vs Multi Cap Funds:
The mindless Sep2020 SEBI regulation on Multi Cap / Flexi Cap funds achieved nothing. Between Dec2020 and Mar2021, 25 AMCs moved their multi cap funds to flexi cap funds (new equity MF category) as can be seen from the data in the table attached below.
Total assets of multi cap funds category dwindled precipitously from Rs 1.68 lakh crore at the end of Dec2020 to Rs 19,900 crore as of Mar2021, recording a fall of 88 percent. That AMCs shifted such huge amounts from one to another MF category is a big thumbs down to SEBI's clueless regulation.
Fund managers moved to flexi cap funds because they offer a higher degree of operational flexibility to them in terms of moving freely and dynamically, as per the market opportunities, among stocks irrespective of their market caps.
On the other hand, money managers are constrained by SEBI's new regulation of Sep2020 on multi cap funds -- which mandated multi cap funds should invest at least 25 percent of their total assets in each category of large-, mid- and small-cap stocks.
As can be seen from the data, between Mar2021 and Jan2024, number of schemes under multi cap increased from 10 to 24, whereas flexi cap schemes increased from 25 to 38 in the same period.
AMCs are in the habit of asset gathering, and as such they often tend to introduce new plans in the process. That they again introduced, between Mar2021 and Jan2024, multi cap funds for gathering more assets and more fees is a different matter (it may be noted there are 43 AMCs now in India).
2.Equity schemes - How total assets and # of schemes changed:
AMFI started
publishing mutual fund data in the current format (giving details as per Oct2017
SEBI norms on Categorization of MFs) effective from the month of April 2019. So, from Apr2019 onwards, one could analyse how the assets and number of schemes increased among equity mutual funds.
As shown in the table below, between Apr2019 and Jan2024, number equity schemes increased from 307 to 427; whereas their total assets increased Rs 7.04 lakh crore to Rs 22.50 lakh crore, a rise of 220 percent, during the period.
The biggest rise in number of schemes is from thematic / sectoral funds -- in less than five years, AMCs launched 59 new schemes.
As
the number of equity MF category is limited to eleven only, the AMCs
have been increasingly launching more and more schemes under the
thematic / sectoral fund category.
The biggest rise in total assets is from: Small Cap, Dividend Yield and Sectoral / Thematic fund categories. Small- and Mid-cap stocks have given spectacular returns in the past one year; so are the so-called dividend yielding / value stocks.
Total assets increase is driven by a combination of increasing net flows to the funds, number of new fund offers (NFOs) launched and general rise in stock market indices over a period of time.
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References:
SEBI circular dated 06Oct2017 on Categorization and Rationalization of Mutual
Funds -- web archive for this circular - AMFI weblink for this circular
SEBI circular dated 04Dec2017 on Categorization and Rationalization of Mutual
Funds -- web archive for this circularSEBI circular 11Sep2020 on Asset Allocation of Multi Cap funds
Tweet thread 11Sep2020 on expected Rs 40,000 crore "bonanza" after SEBI
changed Multi Cap fund norms
Morningstar article 12Sep2020 on impact of SEBI's norms on Multi Cap funds
SEBI clarification 13Sep2020 on Asset Allocation of Multi Cap Funds
Several tweets (search of SEBI categorization)
Tweet thread dt 22Feb2024 on SEBI Categorization and Rationalization of Mutual
Funds
X post / Tweet thread dated 28Jan2024 on strange phenomenon of multi cap funds outperforming flexi cap funds
AMFI list: Categorization of Large-, Mid- and Small-cap stocks
AMFI list: PDF for half-year ending Dec2023
AMFI monthly data on AUM
AMFI started publishing MF data in the current format (giving details as per Oct2017 SEBI norms on Categorization of MFs) effective from Apr2019
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Disclosure: I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if any.
Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets.
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