MF recategorisation norms: Only some schemes will be impacted by Sebi rule

The new mutual fund re-categorisation norms will require you to take a closer look at your portfolio to assess the impact

Investors are currently receiving communiqués from their fund houses informing them about the changes being made to their funds to comply with the Securities and Exchange Board of India’s (Sebi) circular on categorisation of schemes that came in October 2017. While a few funds are being merged (less than 10 per cent of the total), many are being shunted from one category to another. In some cases, their fundamental attributes are being changed. Investors need to understand, preferably with the aid of a financial advisor, how drastic have been the changes in the character of their funds, and then decide whether they call for any action on their part.

Change may appear drastic, but may not be so: Going by the change in the nomenclature of some funds, it may appear that there has been a material change in their mandate. But it may not be so. HDFC Top 200 (asset under management or AUM Rs 143.49 billion) will now morph into HDFC Top 100. “The name change may seem like a narrowing of the mandate. But if you look at its portfolios of the recent past, the fund manager was already investing 85-88 per cent in the top 100 stocks. So there won’t be much of a change in how the fund is run,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Advisor India. 

Sometimes, even where the fund’s category has changed, the way the fund is run may remain unaltered. Take the example of HDFC’s balanced funds. The fund house had two funds in this category: HDFC Balanced and HDFC Prudence. The former will move to the aggressive hybrid category, with an equity allocation (65-80 per cent) similar to what it has now. HDFC Prudence is being merged with HDFC Growth and will move to the dynamic asset allocation or balanced advantage category. In this category, fund houses have complete leeway to select their equity:debt allocation (1-100 per cent in either direction). Market sources, based on their interactions with the fund house, say that even after the change, HDFC Balanced Advantage Fund, as the merged entity will be called, may be run with a similar equity:debt allocation as it has now. 

There may be a situation where a large-cap fund moves to the large- and mid-cap category. In this case, investors will need to check the fund’s exposure to large-cap stocks before and after the change. The exposure may change by only around 10-15 percentage points, or even less. This change will have only a limited impact on the overall category allocation (allocation to large-, mid and small-cap stocks) of an investor’s portfolio.

Where changes are material: Suppose that a small- and mid-cap category fund, which earlier held 60 per cent in mid-caps and 40 per cent in small-caps, now gets reclassified as a small-cap fund, wherein the fund manager will have to hold at least 65 per cent in small-caps. A 25 percentage point increase in allocation to small-cap stocks is a significant change.

In some cases, the fund’s investment style could change. SBI Magnum Equity, for instance, is set to become a thematic fund. IDFC Sterling Equity, which is currently (according to Morningstar’s style box) a mid-cap growth fund, will turn into a value fund. “If you want the value strategy, stay invested. But if you had entered the fund for a mid-cap, growth-oriented exposure, exit and enter another fund,” says Vidya Bala, head of research, Fundsindia.com.

What should investors do? Fund houses should complete the changes to their fund portfolios by June end. Experts say that investors should wait for another quarter after these changes for the portfolios to settle down. Then, with the help of an advisor, they should look at how the changes have affected their asset allocation (equity:debt mix) and category allocation. Thereafter, make changes so that your portfolio once again becomes aligned to your risk appetite and financial goals. 

Only if the change in mandate is drastic, and you don’t have the appetite to handle the risk that comes with it, should you exit right away. Say, a large-cap fund becomes a small-cap fund, or a large-cap fund changes into a multi-cap fund with a concentrated strategy, move out right away. 

Also examine the change in each fund within your portfolio. Suppose that a large-cap fund becomes a multi-cap fund. “Running a multi-cap strategy entails picking both large-cap and mid- and small-cap stocks. A fund manager who has been running only a large-cap strategy in the past may not be well equipped to run this strategy,” says Belapurkar. Either wait to see if the fund manager is able to cope with the change, or shift to a multi-cap specialist. 

In the new regime, large-cap has been defined as the top 100 stocks and midcaps as 101-250 stocks. Investors will need to continuously monitor their funds’ performance to see if their fund managers are able to generate alpha in the new regime. “In the past, outperformance came from going outside the mandate. The ability to do so will get restricted,” says Nikhil Banerjee, co-founder, Mintwalk. Adds Bala: “Fund managers will have to learn to generate alpha by going overweight or underweight in stocks and sectors. Their ability to do so successfully should be monitored closely,” says Bala.  

Investors wishing to add a new fund (one which they don’t already own) should avoid those whose fundamental attributes have changed drastically. “Future performance may be very different from historical performance because of the change in strategy,” says Banerjee. Bala adds that there are enough funds whose fundamental attributes have remained unchanged, so stick to them.

“Investors should consult their respective financial advisors to see if there has been a material change in the risk-return profile of the fund. It is better to be patient for the time being, wait for the industry to implement changes and then decide on the appropriate course of action,” says Raghav Iyengar, EVP and head, retail and Institutional Business, ICICI Prudential Asset Management.

Finally, if you have to exit a fund, weigh the tax implications. Except where the changes are difficult for you to stomach, wait until a year has elapsed so that you are subject to long-term capital gains tax (10 per cent), rather than pay short-term capital gains tax (15 per cent).