Why Mutual Fund Investing Has Just Got Easier – And A Bit More Confusing

If you have been a regular investor in mutual funds, you would have got a flurry of mails from fund management companies talking about changes in fee structures, recategorisation of schemes or even mergers. Well, your life has just gotten more complicated.

Two reasons why: one, last October, Securities and Exchange Board of India (SEBI) ordered all mutual funds to stick to 36 basic categories – 10 equity, 16 debt, six hybrids, two special purpose schemes (eg: retirement or children’s endowment), and two “others” that include index and exchange-traded funds, and overseas or domestic fund of funds.

And two, now that mutual funds are beginning to comply, the basic character of many schemes may be changing, at least at the margin.

Put simply, the scheme you invested in may not be the scheme you now have in your portfolio, and as fund managers shuffle their investments to comply with the new norms, there could be temporary gyrations in net asset values. Among other things, SEBI has specified how much a fund can invest in large-caps or mid-caps, how much it can divide its portfolio between equity and debt; and which kind of debt investments are valid based on the new character of various types of debt funds.

The purpose of investing in a mutual fund is to avoid all the trouble of researching stocks and tracking corporate performance and letting professionals do this on your behalf. But given the growing complexity of mutual funds themselves, even the SEBI’s decision to reduce the number of categories to 36 is not going to make life any easier.

However, there is a bright side to the story. Any future investment in mutual funds will be easier, as funds will be defined by categories, and not names that mean nothing. In the past, equity funds have been given exotic names like LION fund, or TIGER fund, when basically these were just growth-oriented equity funds.

Now, under SEBI’s tutelage, there will be only 10 broad categories of equity funds: multi-cap funds, large-cap funds, large-cum-mid-caps, pure mid-caps, pure small-caps, value or contra funds, focused funds, sector funds, and tax-savings funds (equity linked savings schemes, or ELSS). That’s still 11 kinds of funds, and not 10, but SEBI has decreed that fund houses can either offer Contra funds, which take up contrarian bets, or value funds, which try to buy shares that are relatively underpriced. Funds can’t have both types, contra and value. Focused funds are those that, say, invest only in index stocks, or the top 30 stocks, etc. (You can get all the details here)

But when it comes to debt, the field suddenly gets too large even after the simplification, with 16 categories to choose from: overnight, liquid, ultra short-term, low-duration, money market, short duration, medium duration, medium-to-long duration, long duration, dynamic bond, corporate bond, credit risk, bank and PSUs, gilts, gilts with constant 10-year duration paper, and floater funds.

In the hybrid category, the options range from conservative and balanced funds, where debt is the dominant investment, aggressive hybrids, equity savings and arbitrage funds, which are loaded towards equity and thus taxed at 10 per cent for long-term gains, and dynamic asset allocation and multi-assets funds – which will be pretty diverse.

If you want to know what has happened to your fund now that it has changed character, and possibly also changed its name, this Economic Times article is a good place to start. Thus, the ICICI Prudential Top 100 and SBI Magnum Multiplier funds are now large and mid-cap funds; and HDFC Balanced Fund is now HDFC Hybrid Equity.

Where fund houses were running multiple schemes in the same category, they are merging them into one. Thus, L&T Taxsaver and L&T Equity Growth Fund, earlier categorised as ELSS, have been merged to become a multi-cap fund. The UTI Multi-cap Fund has become a Value Fund and renamed.

The same has happened with debt schemes. Investors have a 30-day window in which to exit a scheme which has changed character after the SEBI-mandated rejig.

So, what should you do?

While it’s possible that you may want to switch schemes whenever their basic character has changed, it is probably a good idea to sit tight and do nothing for a while.

Two reasons why:

One, past performance is no longer a guide, as your existing scheme as well as the new one will have no track record to show you how they did. If earlier your fund manager could oscillate between stocks in the Top 100, today, if it has become a large cap-cum-mid-cap fund, its universe of stock picks would have changed. SEBI categorises the top 100 stocks by market capitalisation as large-cap, and the next 150 as mid-caps, and those after 250 as small-caps. And based on market performance, the stocks in each of these categories will keep changing every six months. So, even if you have invested in a diversified fund, and now it has become multi-cap, you should wait to see performance settle down before taking a leap in the dark.

Two, switching out from an existing scheme means you may incur taxes on the sale before reinvestment happens in a new scheme.

Broadly speaking, the SEBI-prompted changes are confusing for existing investors, but new investors may find that finding the right fund has just gotten easier. That’s the tradeoff. It’s about simplifying investment in future.