Insights

FundsIndia Views: Scheme re-categorization and what it means for you

April 4, 2018 . Vidya Bala

You would have been receiving mails from fund houses and from us on changes in scheme categories of funds, to fit into SEBI’s newly defined categories. If you are not updated on this please read our earlier post on what this is all about before going ahead with this one.

These mails would have provided you with details of some or all of the following:

  • Change in scheme name
  • Change in category
  • Change in fundamental attributes of a fund
  • Merger of schemes

The entire MF industry is undergoing this overhaul and it is not complete yet. Should you be worried this? What is its impact? Let me sum it up for you in three points:

  • The good news is that there are very few scheme mergers. There is a lot of change in categories but a good number of these are simply re-categorization – that is, reclassifying into SEBI’s new categories without any change in strategy. Similarly, there are name changes just to resonate the category heading. These are ‘minor’ changes in fundamental attributes that will have little or no impact on the fund strategy and performance. So, most of you are unlikely to be impacted and none of these need to worry you.
  • The not so good news is that some funds are likely to undergo a change in strategy. But you will have to wait for all the announcements to see if you must rebalance your overall category allocation. For example, if your midcap fund has become a large and mid-cap fund then would the return potential go down is something that needs to be assessed.
  • Now for the bad news: choosing funds, especially if you are a do-it-yourself investor, is going to be a tricky and challenging, for the next year or two. There is a good chance that past performance can mislead you.

This article will detail the above points for you and let you know what you should be doing about the news that is not positive.

Why the change?

SEBI came up with scheme categorization and rationalisation to bring uniformity in categorizing funds across AMCs, uniformity in the way each category of funds behaves and ensure every fund house has just one scheme under such defined strategy/market cap. It therefore proposed various categories into which fund houses should fit their present schemes or merge them if there were more than one under each. It has also defined the universe of instruments that a fund house can invest in under each such category.

Have these objectives been achieved in the present re-categorization done by AMCs? Only partly. All fund houses will now have to uniformly classify their schemes under the stated categories. However, it appears that fund houses have managed to fit most of their funds in the new categories. That means, there are still many schemes within the same fund house. And there is still some amount of duplication in strategy. A focused fund (a category of fund under the new circular) can be a large cap or a multi-cap or a large and midcap. Hence, it may have a focused strategy but with a similar market-cap as a sister fund. Or a large and midcap fund may not be too different from a multi-cap fund. Simply put, the new scheme categorization has not entirely done away with duplication.

To this extent, there have been few mergers thus far. But on the flip side, you still have a problem of plenty.

What kind of change?

As discussed earlier, scheme mergers have been less in number. For the vast majority of funds, there have been name changes, definition of a fund’s category where it wasn’t defined before, or a reclassification into a new category. Such instances, though small, qualify as a fundamental change in attributes because it involves a change in what was detailed in the scheme documents. But even a small change in a scheme attribute would mean providing you with an exit option. This does not automatically mean that the change is significant.

In our assessment, thus far, major changes in the nature and strategy of funds have been few. We consider a change to be significant where the portfolio can undergo changes in market cap, or its investment strategy, or needs rebalancing of its portfolio when compared with the market cap or strategy followed before the circular. Given below are some of the large AMCs that have published the new categories. You will see that the number of mergers is not high. Nor is the number of funds with potential changes in strategy.

Fund HouseNo. of mergersNo. of funds with significant change in strategy*
Aditya Birla Sun Life MF82
Reliance MF13
UTI MF5None
ICICI MF63
Franklin India MFNoneNone
DSP BR MFNoneNone
* A fund with mere category change without any such change mentioned above was not counted for this purpose.

(Click here for other changes and details of changes)

While significant changes are not too many, some of them attract attention. For example, ICICI Pru’s Dynamic Bond fund is to be merged with ICICI Pru Banking & PSU Fund! Their more popular ICICI Pru Long Term (now called the All Seasons fund) will remain the AMC’s dynamic bond offering. And then strangely ICICI Pru Indo Asia Equity Fund is to become a small-cap fund! Who would have thought of that?

In debt, the categorization between ultra short term and low duration and money market should not bother retail investors much. However, a short-term fund (Aditya Birla Sun Life Short Term) becoming a corporate bond fund (holding highest credit rated papers but without mention of portfolio tenure) or a treasury optimizer fund (from Aditya Birla) becoming a Banking & PSU fund are not like to like category moves.

What seems evident is that fund houses with compact funds such as Motilal Oswal, Mirae or Invesco or those that had funds with clearly defined strategies such as Franklin India or UTI have come up with a list that had minimum disruptions. Even there, a star fund like Mirae Asset Emerging Bluechip moving to the large and mid-cap category (where it needs to hold a minimum of 35% of assets in large cap) can cause some impact to other funds.

Overall, there are some changes that may not impact your portfolio directly but require you to assess whether your original category allocation has been impacted. This, in our opinion, can be done when you do your regular half yearly or annual review with your FundsIndia advisor.

As far as our researched list goes – barring category changes in Mirae Asset Emerging Bluechip and debt fund ABSL Short Term, there is no other change thus far. We maintain a hold on these funds. This limited change in our list can be partly attributed to our sticking to funds with clear, distinct strategies and avoiding duplicates within a fund house.

What can change

Looking at past performance – whether for your own return expectations or for comparing peer funds – will be difficult for the next 8-12 quarters at least. To this extent, comparing and choosing funds can be tricky if you try to do it yourself.

Let me explain this with an example: In the above-mentioned change of Mirae Asset Emerging Bluechip, it does not take too much for the fund to marginally up its holding to 35% in large caps to qualify under the new category of large and midcap. However, the fund can change the way you look at other peers in the new category. See the table below: It has Mirae Asset Emerging Bluechip along with its new peers under the large and midcap category. Look at the fund’s past returns and see how the peers pale in comparison. Would this make the other funds a poor choice? Not necessarily!

Scheme name3-year returns (%)5- year returns (%)
Mirae Asset Emerging Bluechip17.530.0
ABSL Advantage (to be called ABSL Equity Advantage)10.922.5
DSP BR Equity Opportunities (earlier DSP BR Opportunities) 12.320.0
Invesco India Growth 10.118.9
ICICI Pru Top 100 (to be called ICICI Pru Large & Midcap)8.716.0
Returns as of April 2, 2018. Returns are annualised.

This is where your problem of comparison based on past performance will start and not end until such time the funds accumulate a reasonable period of performance data post these changes. Even then, some categories such as the large and mid-cap or multi-cap can have high variance in fund performance based on their risk profile (exposure to different market caps).

The above problem may persist in quite a few categories. For example, a diversified fund which will move to a value category may sport better 1-year performance compared with existing value funds as value as a theme was underperforming in 2017. Similarly, funds that have now been classified as ‘focused’ may underperform existing focused funds since a focused strategy delivered superior returns in 2017. In debt, the extent of the problem is lesser. A fund with a high credit risk profile now moving to say a corporate bond fund category may seem better than peers as a credit risk fund would have delivered more in the past. But debt now poses the hassle of more categories for you to navigate; even as the asset class by itself is complex enough.

These kind of anomalies, although would reduce with time, will make it tricky for you to compare performances. So, what should you be doing?

What needs to be done

As far as our research approach is concerned, we will be fine-tuning our rating methodology to ensure funds do not suffer because of such peer comparison stated above. Sticking to appropriate fund benchmarks and bringing in more value adding metrics to assess fund consistency are on the cards. We will let you know the changed methodology next quarter, once all the ongoing changes are in place.

As far as you are concerned:

  • Do not be in a hurry to exit and re-enter funds at this stage. Wait for funds to settle into their new categories.
  • Be wary of going merely by the ratings offered by various websites (unless they clearly state what their new methodology is), if comparison is done with new peers based on past data.
  • It is better to check your choice of funds with your advisor to ensure you are not comparing funds whose past record is not comparable.
  • When it comes to reviewing your funds, stick to comparing the fund with its respective benchmark and check if the fund is able to deliver 2-3 percentage points more than the benchmark in the case of equity.
  • Avoid hasty decisions to exit or enter based on returns alone, without knowing whether the fund will fit you in its new avatar.

Invest safely!

FundsIndia’s Research team has, to the best of its ability, taken into account various factors – both quantitative measures and qualitative assessments, in an unbiased manner, while choosing the fund(s) mentioned above. However, they carry unknown risks and uncertainties linked to broad markets, as well as analysts’ expectations about future events. They should not, therefore, be the sole basis for investment decisions. To know how to read our weekly fund reviews, please click here.

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