Sebi gives mutual funds a reality check

Guidelines on returns, classification and labelling will scale back 'outperformance' claims and improve transparency

The mutual fund industry has had a good run for quite some time. Fund collections, especially through systematic investment plans, have been to the tune of Rs 8,064 crore a month — an all-time high.
 
Amid this euphoria, however, the industry has also had to ride through the crisis that hit mid-and small-cap funds, defaults by Infrastructure Leasing & Financial Services and other companies, and of course, implement several guidelines of the Securities and Exchange Board of India (Sebi).
 
Sebi’s changes, which were proposed in October 2017 and notified last year, will have a long-term impact on equity funds’ performance. The new norms have introduced more transparency and will also scale back claims of outperformance by many schemes. This is on account of the introduction of the total return index (TRI) last February. TRI captures both the dividend gains and capital appreciation delivered by the benchmark index. The price return index used earlier only captured the capital appreciation, thereby making fund managers look exceptionally good even when companies paid hefty dividends.
 
“The TRI methodology is more in-line with global norms. In the earlier method, scheme outperformance could get overstated as dividend gains were not included in the benchmarks. Now, investors can take a more informed investment decision,” said Vetri Subramaniam, group president and head (equity), at UTI MF.
 
Another big move by the regulator has been the re-classification of schemes. Under these guidelines, large-cap funds can allocate 80 per cent of their stocks in large-cap companies or the top 100 companies. Mid-cap funds can have 65 per cent in mid-cap stocks, and small-cap funds can have 65 per cent in small-cap stocks. The result of this classification could be that fund managers could find it harder to outperform benchmarks because they won’t be able to dabble too much in riskier stocks.
 
The new regulations require large-cap schemes to invest at least 80 per cent of their funds in the top-100 companies. We have recently seen only a few stocks within this universe outperforming,” Anand Vardarajan, head of business and product strategy at Tata MF said. Last year, 67 of the Nifty-100 stocks underperformed the index returns.

 
Most agree, however, that this is a good move from a hygiene perspective. “Though re-classification puts constraints for most categories, it is positive from the investors’ standpoint because,  earlier, there were some instances of multiple market-cap oriented strategies being run in the same scheme,” Subramaniam added.
 
“Scheme re-classification has been quite an important step because it helps investors make fair comparisons between the various schemes,” said Radhika Gupta, chief executive officer of Edelweiss MF.
 
Added Vardarajan: “Earlier product comparison was difficult as there was a possibility of schemes with different characteristics getting bracketed in the same category. Now, they can easily segregate various schemes when weighing their options.”
 
The regulatory move to make schemes “true-to-label” is meant to make it easier for an investor to narrow his preferences. Consequently, this exercise has been carried out across all kinds of funds. That is, balanced schemes have been classified into three categories – the conservative hybrid (10-25 per cent in equities), balanced hybrid (40-60 per cent in equities and aggressive hybrid (65-80 per cent in equities). Earlier, schemes with 70 per cent equity as well as 50 per cent equity were all bunched together, making it almost impossible for investors to differentiate between them.
 
Such changes were extended across categories on the debt side as well. To ensure investors are not misled, schemes are required to make a certain minimum allocation to stocks that align with the scheme’s mandate.
 
Some players within the MF industry see this as an opportunity for low-cost products such as exchange-traded funds (ETFs) and index funds. These funds reflect the returns of an underlying index of companies and are available at lower fees for investors.
 
The fees charged by ETFs can be as low as 0.1 per cent against fees of 1.5-2.25 per cent charged by large-cap schemes, say analysts tracking the MF industry. “While alpha [outperformance] will persist for mid- and small-cap categories, index funds and ETFs will have a larger role to play in the large-cap space,” Edelweiss MF’s Gupta says.
 
Retail investors haven’t started boarding the ETF bandwagon aggressively, as only seven per cent of ETF assets are owned by individual investors. But some MFs are already exploring opportunities around ETFs and the index funds. In December, Tata MF launched its Nifty ETF. Edelweiss is in the process of launching a debt ETF, which would comprise of government-owned companies. Even though debt markets have faced several challenges recently, an ETF comprising of government-backed debt papers might give some comfort to retail investors.
 
Anticipating this churn from large-cap to ETFs, Sebi recently laid down norms prescribing a minimum number of constituents in the underlying index and weight limits on the constituent stocks. Whether ETF penetration remains at these levels or deepens, such changes by the market watchdog are likely to make MFs safer in the long run.