Over the past two weeks, we covered the changes taking place in equity and debt categories because of SEBI’s new categorization norms. We’ve discussed the impact of the changes, what’s new and what remains as before. This week, we will discuss if, and how, funds in our research list (called FundsIndia Select Funds) change. To summarise these changes:
- The good news is that most Select funds have not seen any change that will impact returns or risk. The categories they have slotted themselves into are in line with what they have been doing so far.
- A few funds have moved to different categories where their portfolios will see a slight rise or dip in risk to comply with minimum requirements of that category’s definition. The underlying strategy will not change.
- A couple may see strategies change over the long term, as they move to different categories. These will require a wait-and-watch approach to understand how this pans out.
Please note that this article makes mention of only those funds and categories where there are some strategy or market-cap changes and states whether they are significant or not. The rest in our list, not discussed, remain the same. Please login to see the full list of Select Funds.
What we do and how it helped
In order to explain the impact of SEBI categorisation on Select funds, an understanding of how we arrive at the Select list is needed. Broadly, SEBI defines categories based on market capitalisation and strategy in equity, based on equity and debt allocations for hybrid, based on duration and credit quality for debt funds. Even prior to this, we have been following a similar method of fund classification.
For equity funds, we base categories on the fund’s average exposure to large-cap stocks, mid-cap stocks, and small-cap stocks over a period of time. Market cap cut-offs for large, mid, and small are based on the average capitalisations of the BSE 100, BSE 500, BSE Midcap, and BSE Smallcap indices. Therefore, the cut-offs for each market capitalisation segment were adjusted to account for market movements.
This ensured that a large-cap fund that began taking too much mid-cap exposure was moved into a different category, or a diversified fund that continuously stepped up mid-cap exposure was compared to mid-cap funds and so on.
For debt funds, we considered both average maturity and the credit profile of the fund over a period of time in order to categorise it. This ensured that a fund that steadily followed a duration strategy was compared to similar funds, or one that took high risk in credit quality did not give it an unfair advantage over those that stuck to safer instruments.
To shortlist funds across debt, equity, and hybrid, we apply several quantitative metrics. These include consistency, volatility, risk-adjusted returns, ability to contain downsides, credit quality, yield-to-maturity, duration and so on. This is also reflected in FundsIndia ratings.
However, while these metrics help in separating out the top layer of performers, relying purely on it will ignore what the fund does in order to generate those returns. That is, fund strategy takes importance. Why?
- A clear and consistent strategy provides a stronger base for the fund to sustain better returns. It also provides more comfort that the fund would continue to outperform, as quantitative metrics are backward-looking.
- Understanding what the fund does allows selection of funds that are distinct from its peers. Portfolio building involves blending of funds that follow different strategies.
- It prevents short-term market movements from influencing fund selection. A fund that banks on momentum stocks to deliver returns, for example, may look extremely good on recent returns but may actually find it hard to generate returns across timeframes.
Because of FundsIndia’s research-driven process of fund categorisation and attention to fund strategy, the portfolio and the market, the Select list has seen minimal changes. Funds have, however, seen name changes. We have mentioned the old name with the new name, if applicable, in brackets.
Equity funds – moderate risk
This bucket has equity funds that sport a large-cap orientation. This could be pure large-cap funds or diversified funds that tend to maintain a predominant bias towards large-cap stocks.
Funds categorised as diversified have either moved to the multi-cap category or to large-and-mid cap. Those that moved to the large-and-midcap category will see a slight increase in risk level as they have to up their mid-cap allocation to 35%. This includes DSP BlackRock Opportunities (DSP BR Equity Opportunities) which ran on a lower mid-cap allocation of around 20% until it began adjusting its portfolio to the new category (using SEBI’s market cap definitions).
Diversified funds moving to the multicap category will mostly continue to run as before since the category’s definition makes no mention of specific allocation ranges.
Funds categorised as large-cap have remained large-cap in the new categorisation. These funds have also more or less maintained around 80% in large-cap stocks and thus will not see much change to adapt to SEBI guidelines. In our list only Invesco India Growth, which was a large-cap fund will move to the large and midcap category and up its midcap exposure a bit. However, since the fund was always more aggressive than its large-cap peers, we do not see this changing its risk profile.
Invesco India Dynamic Equity will move to the hybrid-dynamic asset allocation category. SEBI’s definition for this category is simply “investment in equity and debt that is managed dynamically”. This was what the fund was doing and will continue to do. Equity market conditions will drive its equity-debt allocation. Given SEBI’s wide definition, we see no reason for any change. We will, however, watch this fund given the shift in category.
Equity funds – high risk
This bucket has diversified funds that tend to be more dynamic in their market-cap movement or which have riskier strategies. This apart, mid-cap and small-cap funds fall into this bucket.
Mid-cap funds Mirae Asset Emerging Bluechip and Principal Emerging Bluechip moving to the large-and-midcap category are the major changes here. Both funds are strong performers in the mid-cap space. Mid-cap funds do have a share of large-caps in their portfolios to provide some stability and liquidity. For Mirae Emerging Bluechip, this share was just short of 30% for most of last year. For Principal Emerging Bluechip, the share was already close to 35%. Given that both funds have stayed ahead of the pack even with close to a third in large-cap stocks, the category shift may not be a severe damper on returns. They may, for example, use small-cap allocations to keep returns up. We will watch to see how the fund ensures that returns are not compromised. You may continue to invest in them as part of your mid-cap allocation.
Hybrid – Equity oriented – moderate risk
This list consisted of balanced funds. These will now neatly fit into the hybrid-aggressive category. HDFC Balanced, alone, will undergo some consolidation but retain the strategy. The resultant fund – HDFC Hybrid Equity – will be a hybrid-aggressive fund. It will be HDFC Balanced’s strategy that survives. Therefore, even while there is a consolidation, the impact on the fund is absent. We have a detailed review of the merger here. Other funds in the category will see only name changes.
The one other change in the hybrid aggressive category is that they can now invest up to 80% in equities. Many balanced funds could earlier move up to 75% in equity. Even so, the funds only rarely pushed equity allocations to the maximum. For the most part, they hover around the 70% mark. On the equity side, balanced funds typically move across the market cap range. This allows them to generate higher returns even with lower equity allocations. It’s therefore unlikely that equity exposure and thus risk will move higher just because the category definitions allow them to do so.
Hybrid – Debt oriented
Funds in this space are primarily MIPs or funds that put about 15-25% of their portfolio in equity and the remaining in debt. Like balanced funds, the funds in this bucket have also easily fitted into the conservative – hybrid category.
Funds in the Select list have generally been near the upper end of the 10-25% equity exposure band that SEBI has defined for the hybrid conservative category. Sundaram MIP Aggressive (Sundaram Debt Oriented Hybrid) is one fund that could move higher to near-30%. This practice will be curbed from how. However, the frequency of such moves above 25% was low; since 2015, the fund has gone beyond 30% less than a third of the time. Therefore, change due to the equity cap is minimal. On the debt front, SEBI does not place any restrictions on duration or credit quality. Thus, funds will not need to tweak their portfolios or strategy.
Debt – 6 months to 1 year
Funds in this part of the Select list have either fitted themselves into the low duration category or the ultra short-term category. Per SEBI, low duration funds need to maintain a Macaulay duration of 6 months to a year and ultra short-term funds need a Macaulay’s duration of 3 months to 6 months.
For funds that ran an average maturity of less than a year, it is not a stretch to get the Macaulay duration to fit into the new category definitions. Hence, there is no change in strategy here.
The one exception in our list Aditya Birla Sun Life FRF – LTP (Aditya Birla Sun Life Floating Rate Fund). This fund is categorising itself as a floater fund. While the fund is by name a floating rate fund today, it had the freedom to move away from floating-rate instruments if opportunities were not attractive. To this extent, we would need to watch how the fund adapts its portfolio to comply with the requirement. As floating rates work better in rising rate cycles and provide higher accrual, the present interest rate scenario is likely to be favourable for floating-rate instruments.
Debt funds – short term, low risk & moderate risk
Apart from the two funds mentioned below, other funds in this set will become short duration funds; this category requires a Macaulay duration of 1-3 years which is line with the funds’ current profile.
Aditya Birla Sun Life Short-term (Aditya Birla Sun Life Corporate Bond) and Reliance Medium Term (Reliance Prime Debt) will move to the corporate bond category. Corporate bond funds are those that need to maintain at least 80% in bonds rated AA+ and above. There is no mention of the duration the fund should have. In this regard, ABSL short-term fund does not need change its strategy. The fund already maintains high credit quality – it has virtually no investment below AA+.
Reliance Medium takes credit risk, but the extent is not large. On an average, exposure to papers AA and below hovered around 18-24% of the portfolio in the past two years. The credit exposure may have to be pared a notch which will bring its risk down to a small extent. Duration, again, may not need to change.
Debt funds – long term, moderate risk
This set is currently made up of dynamic bond funds and income funds. The dynamic bond funds will continue to be dynamic bond in the new categorisation. SEBI’s definition for the category places no restriction on duration or credit quality.
The income fund in this set, HDFC Medium Term Opportunities (HDFC Corporate Bond) will move to the corporate bond category. The fund has been extremely steady in its strategy, sticking to bonds of high credit quality and following a buy-and-hold approach. Therefore, the fund already checks the boxes for the corporate bond category.
Debt funds – long term, high risk
This set includes income funds that have some allocation to papers of low credit quality as well as credit opportunity funds. Funds here have either moved to the credit risk category or the medium duration category. Where they have moved to the credit risk category, there will not be any change other than a possible slight increase in credit risk DSP BlackRock Income Opportunities (DSP BlackRock Credit Risk). SEBI’s criteria for the category requires 65% minimum allocation to papers rated below AA+, and the DSP fund is below this level.
Aditya Birla Sun Life Medium Term Plan and Kotak Medium Term Plan will both move to the medium duration category. This category requires a 3-4 year Macaulay duration. It makes no mention of minimum credit quality to be maintained. Average maturities for the two funds have been between 2-5 years over the past three years. To this extent, the change the funds may have to make is likely to be minimal. They may have to increase maturities a notch, but they can continue to follow a credit-opportunity strategy.
Equity sector funds have categorised themselves in the sector/themed category, with no change in themes. Tax-saving funds (both moderate risk and high risk) will continue as ELSS funds. SEBI has no requirements on either of these categories that would need the funds to change their strategies.
What should you do?
- For funds that see no change in risk, portfolio make-up, or strategy, investments can be continued as they have been so far. SIPs can continue to be run and investments made so far can be held.
- For funds that see a marginal increase or decrease in risk too, investments and SIPs can be continued. Marginal change in risk can come by way of increasing mid-cap allocation, reducing equity exposure, increasing or reducing exposure to low-rated credit. The impact on risk and return potential is unlikely to be high enough to warrant a re-look at this time.
- For funds that may see a change in strategy, types of instruments invested in, or duration it is best to continue with investments, including SIPs. Such a change will unfold only over time. We will be closely watching these funds and will sound you off if any action is required on your part.
In the Select funds, we’ll continue with our current system of bucketing based on risk level – either in terms of market capitalisation or credit risk. As before, each bucket will have funds from different categories. We’ll also be tweaking our fund rating methodology to ensure that we’re still making the right comparisons.
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.