Now Is The Time To Review Your Fund Portfolio
The mutual fund classifications have been finally formalised, post the SEBI directives. DSIJ explains the changes and its impact on returns and how should you review your portfolio.
The BSE Mid-cap index is down by more than 10 per cent since the start of this year till now (May 23, 2018). Nevertheless, there are some mid-cap companies that are up by more than 20 per cent during the same period, which translates into their outperformance of the index by 30 per cent. One of the reasons that is being circulated among investors for such diverse performance is large buying by some of the mutual fund scheme of these stocks. What prompted such a huge buying that led to such outperformance was the compliance by fund houses to SEBI’s new categorisation norms.
According to the circular issued by market regulator SEBI in the month of October 2017, every fund house in India was required to standardize features of their mutual fund schemes across categories. This means that if a fund is dedicated to large-caps, it should contain most of the stocks from the large-cap universe, and in the case of mid-cap dedicated fund, it should be holding maximum of mid-cap stocks. Going a step ahead, the circular even defined large-cap, mid-cap and small-cap stocks. Cover Story MF page - 2 Earlier, there were cases where mid-cap dedicated funds were holding lesser of mid-cap stocks and more of small-cap stocks in their portfolio, which exceeded the limit prescribed by SEBI’s new circular. Therefore, these funds needed to buy more of mid-cap stocks to comply with the regulation and hence we are seeing price spurt in some of the mid-cap stocks.
The Past One of the reasons that necessitated such circular from the market regulator was to ensure uniformity in characteristics of the schemes across categories. Earlier, every fund house used their own description of category of stocks. For example, some fund houses used the absolute market cap to classify the stocks into different categories. Therefore, according to their categorisation, a company having market cap of more than `50,000 crore or more was categorised as large-cap. On the other hand, some of the AMCs used relative value of stocks to categorise them under different market caps.
For example, some of the fund houses used top 50 stocks by market cap as large-cap stocks, while others categorised companies present in an index like NSE100 as large-cap stocks. Therefore, there was no homogeneity in the definition of stocks. The problem was further compounded by the fact that if a fund was a large-cap fund, there was no clarification or standard on what portion of total AUM was supposed to be comprised of large-cap stocks. Therefore, similar schemes with similar objective of large-cap dedicated funds had different benchmarks and stocks from different market-caps were present in different proportions.
With such a diversity in the portfolio of funds, it was becoming very problematic and confusing for an investor to select and invest in the right kind of funds that suited his risk profile. Therefore, SEBI stepped in to streamline and standardise the product offerings. The simple objective of the regulator was to bring uniformity in terms of investment mandate across mutual fund houses by defining the investment universe of each category of mutual funds. This will help investors to evaluate various options from the right perspective before making investments in mutual funds.
Most of the fund houses and funds have now complied with the SEBI circular, but this has created further problems for the investors. Investors are now grappling with the changed names and attributes and have no clue about the course of action they need to take. We will decipher these changes for you and present you with broad contours that will help you to review your portfolio and decide on the future course of action.
The Changes
To align the funds with the SEBI circular, the funds had several options, including changing the name, changing fundamental attributes, merger of schemes as also combination of all the above.
Name Change
The simplest change a fund can do is change the name, which is more of a cosmetic change. For example, Edelweiss Large Cap Advantage Fund will be now known as Edelweiss Large Cap Fund and category as large-cap scheme. Similarly, the name of ICICI Prudential Balanced Fund has been changed to ICICI Prudential Equity & Debt Fund, which reflects its correct stance as a hybrid fund. These name changes are basic in natureand do not change the character of the funds in a material way. These funds have been following a style of investing for many years and the current change in names only reflects their investment style. The names have been changed to properly reflect their investment strategy. For example, a fund from Franklin Templeton that was earlier named as Templeton India Growth Fund is now Templeton India Value Fund.
The fund has been following value investment approach since its inception. It is a conservatively managed equity fund with a “Buy and Hold” investment strategy and remains the same even after the change in name. Therefore, the current change in name merely reflects the fund’s alignment with its investment style. Other major funds that have gone through a cosmetic name change and their current name change correctly reflects their investment style are Franklin India High Growth Companies Fund to Franklin India Focused Equity Fund, HDFC Core and Satellite is now HDFC Focused 30. Both the above funds are now focused fund as per SEBI circular. An analysis of their previous portfolios shows that they were following focused approach in their portfolio and had concentrated portfolio. For example, Franklin India High Growth Companies Fund earlier had focused portfolio of 30-35 stocks, but now the maximum stocks the fund can hold is 30.
In addition to the equity-dedicated funds, the names of the bond funds have also been rechristened without a fundamental change in their attributes. For example, Aditya Birla Sun Life Floating Rate Fund - Short Term Plan name has been changed to Aditya Birla Sun Life Money Manager Fund, while IDFC Super Saver Income Fund - Investment Plan, changed its name to IDFC Bond Fund - Long Term Plan. These changes in the names of funds may make you uncomfortable and leave you wondering what these schemes have become now. However, the changes in names can be safely ignored as these will not have any impact on the way the funds are managed. We analysed a total of 483 funds, out of which 25 per cent of the funds have gone through mere name change.
Change In Attributes
But not all the changes done by fund houses to their schemes are cosmetic in nature. There are some funds that have witnessed change in their basic attributes. For example, there is no change in the name of ICICI Prudential FMCG Fund, but its basic attribute has changed to a certain extent. Earlier, it had a mandate to invest 90-100% in equity-related securities of companies forming part of FMCG sector. This has changed now to 80–100%. Also, the fund earlier allocated 0-10% in debt and money market instruments, but it has now changed the allocation to 0-20%. Likewise, the name of HDFC Retirement Savings Fund remains the same, but there is a change in its attributes.
Earlier, the fund was allowed to invest only in equity and debt securities, however, now it can invest in units issued by REITs and InvITs and non-convertible preference shares up to 10% of total AUM. Of course, these are not sweeping changes as these are so minor in nature that these did not even warrant change in the risk label of the fund. But despite such minor changes, these are treated as changes in the fundamental attributes of the fund.
Nonetheless, not all the changes are minor and there are some funds that have undergone substantial changes in their attributes, which include changes in their names as well as their fundamental attributes. The case in point is the SBI Emerging Businesses Fund. The name of this fund is now changed to SBI Focused Equity Fund, which means the fund can invest in a maximum of 30 stocks. This was earlier a Multicap fund with no limitation on number of stocks in the portfolio. Now it is focused fund with maximum 30 stocks in its portfolio. Similarly, HDFC Large Cap that remained largely a focused fund with limited number of stocks (22 in their latest portfolio) is now large-cap and mid-cap fund and the name has been changed to HDFC Growth Opportunities.
Merger
Beyond the above changes, there are also some funds that will lose their existence. These funds will be merged with other funds. For example, ICICI Prudential Gilt Fund Treasury Plan PF Option and ICICI Prudential Short-Term Gilt Fund are now merged to form ICICI Prudential Gilt Fund. This will not have a significant impact on the investors and most of the funds that are being merged are similar in nature. Besides, since the merger is due to the action taken by the fund house, no tax liability arises for the investors, if one remains invested in the merged fund.
Returns: How to measure
There are various reasons for which a fund will have to reconstitute its portfolio. If the change is minor, then the past returns can be used by the investors to get some sense of fund’s performance. However, if the portfolio has gone through a substantial change, the past performances of these schemes can no more be considered as the reference points for judging a scheme's suitability for investment for an individual. The case gets further complicated when two funds are merged and checking the merged fund's performance becomes difficult. Therefore, to avoid confusion among investors over the past performance of merged schemes, SEBI came out with a circular directing mutual fund houses to follow uniform rules. The circular issued in April 2018, came into effect from May 1. According to the circular, “When Scheme A (Transferor Scheme) gets merged into Scheme B (Transferee Scheme) and the features of Scheme A (Transferor scheme) are retained, the performance of the scheme whose features are retained needs to be disclosed.” This will help investors to appropriately look at the performance of schemes and would also imply that the AMC cannot chose to retain the history of the better performing fund at its discretion. The circular further states, “When Scheme A (Transferor Scheme) gets merged with Scheme B (Transferee Scheme) and a new scheme, Scheme C emerges after such consolidation or merger of schemes, the past performance need not be provided.” This means, Scheme C will be treated as a new scheme with new NAV, thereby creating a completely new fund. These clear guidelines by SEBIwill ensure better disclosure standards and empower investors to make well-informed decisions.
Even those funds that have not merged but if there is a change in their attributes, the past returns will not reflect anything about their consistency of returns. For example, a fund that has been categorised as a mid-cap will now have to invest 65% of its corpus into stocks that are ranked from 101 to 251 in terms of capitalisation. Earlier this might not be the strict universe from which they were selecting stocks. Therefore, their past performance and future performance will not gel and you should avoid any comparison between them.
Impact on investors
The entire exercise by the SEBI is pro-investor and is aimed at simplifying the investing process for the investors. With the required changes done by the funds, investors will now have a clear idea of the funds and their basic attributes. Earlier, many of the fund managers used to drift from their investment mandates while managing their funds. Adopting different style of investments, they used to deliver performances that were better than their peers creating a completely new fund. These clear guidelines by SEBIand respective benchmarks. Nevertheless, such outperformance came with its own risk, which defeated the very purpose for which investor had invested in the fund. There were cases where a mid-cap dedicated fund was dominated by small-cap stocks and hence was creating better returns than its peers, but such outperformance also came with added volatility.
In the case of debt funds also, SEBI has drawn broader contours within which the funds need to invest. For example, a corporate bond fund will now have to invest a minimum of 80% of total assets in the highest rated instruments. Similarly, a floater fund need to invest 65% of the total assets in floating rate instruments.
Such clear demarcation in terms of investment instruments for each type of funds will help investors to take more informed decision. They will also know which fund is going to play what role in their entire portfolio.
The entire process of rationalisation and categorisation will create some challenges for the investors. Since most of the investors select funds based on the past performance (we do not recommend that), the recent changes done by mutual funds may make the past record irrelevant for them. It is like erasing everything that you have written and starting afresh. Not only will the fund's past performance become inappropriate, the peers against whom the performance was measured may have also undergone change.
In such a scenario, you should avoid comparing fund’s performance with its earlier peers or even with the past performance of the fund. The best thing you can do is to compare the performance of the funds with their new benchmarks. As most of the funds might have changed their underlyings and hence their benchmarks too, you should use the new benchmark or index to judge the performance of the funds. This should be done for the next few quarters till the dust around the entire process settles down and a clear picture emerges out of it.
Re-Examine Your Portfolio
You might have also received communication from the fund houses about the changes in your fund’s name, attributes or merger and might have become confused about what to do next. Where there is only a change in the name of the funds you hold, you can remain invested in the funds. However, if your funds have gone through a fundamental change in their attributes, you need to re-examine the latest holdings in the portfolios of these funds to find out if these are still aligned to your risk profile and whether these reconstituted funds will help you achieve your financial goals. Besides, you also need to examine your entire portfolio of fund and their holdings. It may be the case that there are little changes in your individual funds, but the character of the overall fund’s portfolio might have changed. Hence, you need to examine your portfolio at two levels, one is at the individual fund level, and second at the portfolio level.