Mutual fund houses are in a catch 22 situation these days.
And here’s the reason…
Recently, the Securities and Exchange Board of India (SEBI) issued detailed guidelines on the mutual fund classification — a move that’s expected to reduce the total scheme count by at least a fifth. When the new guidelines were rolled out, mutual fund houses had made encouraging comments showing their preparedness to the likely scheme mergers and fulfilling other compliance requirements.
One month on, the mood has turned febrile.
Mutual fund houses have suddenly realised what initially seemed easy to comply with isn’t a cakewalk.
Media reports suggest that Association of Mutual Funds in India (AMFI) is likely to request the SEBI to reconsider mutual fund classification guidelines.
As you might be aware, the regulatory body recently laid down clear-cut guidelines on the permitted asset allocations for the equity-oriented schemes. Also, it has offered explanation on how the large cap, mid caps, and small caps would be defined for the asset allocation purpose.
As per SEBI guidelines, equity oriented schemes must follow the rules below:
- Large cap oriented schemes should invest at least 80% of their assets in large cap stocks.
- Large and mid cap schemes shall have minimum allocation of 35% in each.
- Similarly, mid cap schemes and small cap schemes shall invest at least 65% in mid cap and small cap stocks respectively.
And here’s how the market capitalisation categories are defined:
- Large caps: First 100 companies on full market capitalisation basis
- Mid caps: All companies from 101st to 250th on full market capitalisation basis
- Small caps: All other companies from 251st onwards on full market capitalisation basis
Now mutual funds are voicing their concerns on these norms for they forcing fund managers to take higher risks. On a condition of anonymity, the CEO of a mid-sized mutual fund house said, “The biggest hurdle is the restriction of market capitalization for equity funds that will limit choice of stock.” And added further that, “Funds houses are individually approaching the regulator on their interpretation of rules and concerns. After getting a feedback from all the fund houses AMFI will send a formal communication to the regulator.”
A fund manager of the same fund house echoed these views saying, “This stricture may limit our picks and increase the overall risk in the fund.”
“There are cases where a fund house has two similar looking schemes and both of them have a good track record. Fund houses are considering to tweak them as shutting them down or merging them will create a fund with assets too large to manage”, he said further.
Are these the real issues?
It doesn’t look like it, because, before finalising the guidelines SEBI had offered enough time for mutual fund houses to express their views on the subject. Thus, weeping about new guidelines at this juncture looks like an attempt to rain on the parade.
Why are mutual fund houses so worried?
When fund houses are questioned about the rationale of offering a product-heavy bouquet, they explain that the products are offered satisfy specific investors’ requirements. For example, a fund house offering a dedicated small cap scheme would say that, it offers the scheme for those who want to have exposure exclusively to small caps. You will hear similar reasons for other product categories. And if it’s true in deed; what the harm if new guidelines draw some boundaries around their asset allocation?
The new norms will expose them — their protest now suggests that, investors don’t need so many schemes indeed.
Are new norms effective?
Yes they are.
So far the fund houses were arbitrarily defining large caps, mid caps, and small caps, among other schemes. The new norms will bring uniformity in the operations of all mutual funds. Thus, comparing the performance of two schemes within the same subcategory will reflect an accurate picture of competence, in the future.
The capital market regulator has also prohibited fund houses from emphasising only on the “return” aspect of the offering while naming the scheme. For example, “High-yield Fund” can mislead the investors. Hence, such words and phrases can’t be used in isolation in the name of the schemes.
In conclusion…
Fund houses are crying wolf about the negatives of the new regulations. They don’t have problems with launching New Fund offers (NFOs), since SEBI has permitted them to have a scheme each category. But when their flexibility is challenged to protect investors’ interest, they start feeling the trouble.
What investors should do?
You shouldn’t fall for the NFOs — you don’t need them. Instead, invest in schemes having a superior track record across timeframes and market cycles.
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