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SEBI's Categorization and Rationalization of Mutual Fund Schemes

Created on 24 Oct 2020

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Mutual funds were made to make investing easy, so investors would not have to be burdened with picking individual stocks. There were two qualities about the mutual funds of the 1920s that made them extremely speculative. One was that they were heavily leveraged. Second, mutual funds were allowed to invest in other mutual funds. 

Why were mutual funds recategorized?

As of late, SEBI, through a circular, came up with categorization and rationalization of mutual funds schemes. It is a push to achieve consistency in the working of AMCs and to normalize characteristics of Mutual Fund schemes across explicit classes. 

Under this guideline, the fund houses need to characterize their mutual fund's schemes unmistakably. The product contributions need to be different from one another regarding centre characteristics like investment goal and asset allocation. This would help mutual fund investors to inspect a Mutual fund scheme appropriately before finishing the choice to invest in it.

SEBI has indicated 36 categories of mutual fund schemes altogether. According to the new guidelines, the AMCs won't be permitted to offer two schemes under various names with indistinguishable speculation mandates. One class of mutual funds will be allowed to sell just a single scheme. Because of this order, the MF houses are currently realigning their plans and portfolio to arrange them under the recently framed categories.

Essentially, SEBI needs to decrease ambiguity for investors. Thus, according to the new circular, one mutual fund company can have just one plan under every category. Let's look at how it will affect the investors.

How will it affect investors?

Priorly, SEBI had given instructions to merge a similar scheme under one category, but companies showed resistance. Hence, SEBI finally had to issue a circular.

This circular says that different schemes launched by an MF should be unique in terms of asset allocation, investment strategy, etc. Further, it is important to bring in uniformity in the characteristics of similar types of schemes launched by different Mutual Funds. This would ensure that the investor can evaluate different options before deciding to invest.

As a Mutual fund investor, you have to comprehend the most recent classification of mutual funds to make educated choices. SEBI has achieved the accompanying changes with respect to the categorization.

How were Mutual Funds recategorized?

Order of Schemes 

Before the most recent guideline, there was an absence of clarity concerning what comprised a particular classification of mutual funds. There were meagre lines of separation, particularly with respect to multi-cap or large-cap. 

The speculation mandate was not followed by the overall risk profile of the fund and asset allocation. After the recategorization, SEBI has indicated the whole universe of mutual funds to be grouped under these 5 categories.

Naming of Schemes 

The new guideline requires renaming of the schemes to unmistakably show the degree of danger associated with the investment. Presently, the fund houses would need to drop extravagant names from their common asset offering to mirror the genuine picture.

Previously, the mutual funds' scheme name consisted of words like "opportunities", "advantage" and "prudence" to make it look worthwhile, because of which the speculator couldn't measure the characteristic danger while making a venture. After the passing of the guideline, many plan names have been changed to upgrade existing revelation.

Presentation of Lock-in Period 

SEBI has presented a lock-in period in the event of Solution Oriented Schemes like retirement assets and children's fund. Be that as it may, the existing investors of the scheme need not stress over it because the said lock-in period would not apply to them. Furthermore, a similar guideline applies to existing Systematic Investment Plans (SIPs) and approaching systematic transfer plans (STPs).

Change of scheme attributes

Aside from the category and name of the scheme, the fund house needs to change different parts of the scheme with it to align it with the said guideline. These include the investment mandate, the benchmark, and the investment strategy of each mutual fund scheme.

Categories under Mutual Funds

The circular suggests that dissimilar MF schemes should be particular regarding investment strategy and asset allocation. The schemes are extensively arranged into the following categories:

  • Equity Schemes
  • Debt Schemes
  • Hybrid Schemes
  • Solution-oriented Schemes
  • Other Schemes

Equity Schemes

The equity schemes can have 3 subcategories; Large-cap, Midcap, and Small-cap

  • Large Cap- 1st – 100th company in terms of market capitalization.
  • Mid Cap- 101st – 250th company in terms of market capitalization.
  • Small-Cap- 251st onwards in terms of market capitalization.

S. No.

Category of Scheme

Characteristics

Type of scheme

1

Multi Cap Funds

Minimum investment in equity & equity related instruments–65% of total assets.

Multi Cap Fund – An equity mutual fund investing across Large Cap, Mid Cap, Small Cap stocks.

2

Large Cap Fund

Minimum investment in equity & equity related instruments of large cap companies – 80% of total assets.

Large Cap Fund – An equity mutual fund predominantly investing in Large Cap stocks.

3

Large & Mid Cap Fund

Minimum investment in equity & equity related instruments of large cap companies – 35% of total assets

Minimum investment in equity & equity related instruments of mid cap stocks – 35% of total assets.

Large & Mid Cap Fund – An open-ended equity mutual fund investing in both large cap and mid cap stocks.

4

Mid Cap Fund

Minimum investment in equity & equity related instruments of mid cap companies – 65% of total assets.

Mid Cap Fund – An equity mutual fund predominantly investing in Mid Cap stocks.

5

Small Cap Fund

Minimum investment in equity & equity related instruments of small cap companies – 65% of total assets.

Small Cap Fund – An equity mutual fund predominantly investing in Small Cap stocks.

6

Dividend Yield Fund

Scheme should predominantly invest in dividend yielding stocks. Minimum investment in equity – 65% of total assets.

An equity mutual fund predominantly investing in dividend yielding stocks.

7a

Value Fund*

Scheme should follow a value investment strategy. Minimum investment in equity & equity related instruments – 65% of total assets.

An equity mutual fund following a value investment strategy.

7b

 Contra Fund*

Scheme should follow a contrarian investment strategy. Minimum investment in equity & equity related instruments – 65% of total assets.

An equity mutual fund following contrarian investment strategy.

8

 Focused Fund

A scheme focused on the number of stocks (maximum 30) Minimum investment in equity & equity related instruments – 65% of total assets.

An equity scheme investing in maximum 30 stocks (mention where the scheme intends to focus, viz., multi cap, large cap, mid cap, small cap).

9

 Sectoral/Thematic

Minimum investment in equity & equity related instruments of a particular sector/particular theme – 80% of total assets.

An open-ended equity scheme following the theme as mentioned.

10

 ELSS

Minimum investment in equity & equity related instruments – 80% of total assets (in accordance with Equity Linked Saving Scheme, 2005 notified by Ministry of Finance).

An open-ended equity linked saving scheme with a statutory lock in of 3 years and tax benefit.

Debt Schemes

The obligation reserves have been additionally separated into the following 16 sub-classifications, including overnight fund, liquid fund, ultra-short duration fund, low duration fund, money market fund, short-duration fund, medium duration fund, medium to long-duration fund, long-duration fund, dynamic bond fund, corporate bond fund, credit risk fund, banking & PSU fund, Gilt Fund, Gilt fund with 10-year constant duration and floater fund.

S. No.

Category of Scheme

Characteristics

Type of scheme

1

Overnight Fund

Investment in overnight securities having maturity of 1 day.

A debt scheme investing in overnight securities.

2

Liquid Fund

Investment in Debt and money market securities with maturity of up to 91 days only.

A liquid scheme.

3

Ultra-Short Duration Fund

Investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is between 3 months – 6 months.

An ultra – short term debt scheme investing in instruments with Macaulay duration between 3 months and 6 months.

4

Low Duration Fund

Investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is between 6 months – 12 months.

A low duration debt scheme investing in instruments with Macaulay duration between 6 months and 12 months.

5

Money Market Fund

Investment in Money Market instruments having maturity up to 1 year.

A debt scheme investing in money market instruments.

6

Short Duration Fund

Investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is between 1 year – 3 years.

A short-term debt scheme investing in instruments with Macaulay duration between 1 year and 3 years.

7

Medium Duration Fund

Investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is between 3 years – 4 years.

A medium-term debt scheme investing in instruments with Macaulay duration between 3 years and 4 years.

8

Medium to Long Duration Fund

Investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is between 4 – 7 years.

A medium-term debt scheme investing in instruments with Macaulay duration between 4 years and 7 years.

9

Long Duration Fund

Investment in Debt & Money Market Instruments such that the Macaulay duration of the portfolio is greater than 7 years.

A debt scheme investing in instruments with Macaulay duration greater than 7 years.

10

Dynamic Bond

Investment across duration.

A dynamic debt scheme investing across duration.

11

Corporate Bond Fund

Minimum investment in corporate bonds – 80% of total assets (only in highest rated instruments).

A debt scheme predominantly investing in highest rated corporate bonds.

12

Credit Risk Fund

Minimum investment in corporate bonds – 65% of total assets (investment in below highest rated instruments).

A debt scheme investing in below highest rated corporate bonds.

13

Banking and PSU Fund

Minimum investment in Debt instruments of banks, Public Sector Undertakings, Public Financial Institutions – 80% of total assets.

A debt scheme predominantly investing in Debt instruments of banks, Public Sector Undertakings, Public Financial Institutions.

14

Gilt Fund

Minimum investment in Gsecs – 80% of total assets (across maturity).

A debt scheme investing in government securities across maturity.

15

Gilt Fund with 10-year constant duration

Minimum investment in Gsecs – 80% of total assets such that the Macaulay duration of the portfolio is equal to 10 years.

A debt scheme investing in government securities having a constant maturity of 10 years.

16

Floater Fund

Minimum investment in floating rate instruments – 65% of total assets.

A debt scheme predominantly investing in floating rate instruments.

Hybrid Schemes

The hybrid funds have additionally been divided into the following 6 subcategories, i.e. conservative hybrid fund, balanced hybrid fund, aggressive hybrid fund, balanced advantage fund, multi-asset allocation fund, arbitrage fund, and equity savings fund.

S. No.

Category of Scheme

Characteristics

Type of scheme

1

Conservative Hybrid Fund

Investment in equity & equity related instruments – between 10% and 25% of total assets; Investment in Debt instruments – between 75% and 90% of total assets.

A hybrid mutual fund investing predominantly in debt instruments.

2A

Balanced Hybrid Fund

Equity & Equity related instruments – between 40% and 60% of total assets; Debt instruments – between 40% and 60% of total assets. No Arbitrage would be permitted in this scheme.

50-50 balanced scheme investing in equity and debt instruments.

2B

Aggressive Hybrid Fund

Equity & Equity related instruments – between 65% and 80% of total assets; Debt instruments – between 20% – 35% of total assets. Most of the balanced funds will fall into this category.

A hybrid scheme investing predominantly in equity and equity related instruments.

3

Dynamic Asset Allocation or Balanced Advantage

Investment in equity/ debt that is managed dynamically. All famous balanced advantage or dynamic funds will fall into this category.

A hybrid mutual fund which will change its equity exposure based on market conditions.

4

Multi-Asset Allocation

Invests in at least three asset classes with a minimum allocation of at least 10% each in all three asset classes. Foreign investment will be considered as a separate asset class.

A scheme investing in 3 different assets classes.

5

Arbitrage Fund

Scheme following arbitrage strategy. Minimum investment in equity & equity related instruments – 65% of total assets.

A scheme investing in arbitrage opportunities.

6

Equity Savings

Minimum investment in equity & equity related instruments – 65% of total assets and minimum investment in debt – 10% of total assets. Minimum hedged & unhedged to be stated in the SID.  Asset Allocation under defensive considerations may also be stated in the Offer Document.

A scheme investing in equity, arbitrage, and debt.

Solution-Oriented Funds

The solution-oriented funds have been divided into the following 2 subcategories, i.e. retirement fund and children's fund. These funds will have a lock-in period of at least 5 years.

S. No.

Category of Scheme

Characteristics

Type of scheme

1

Retirement Fund

Scheme having a lock – in for at least 5 years or till retirement age whichever is earlier.

A retirement solution-oriented scheme having a lock-in of 5 years or till retirement age (whichever is earlier).

2

Children’s Fund

Scheme having a lock – in for at least 5 years or till the child attains age of majority whichever is earlier.

A fund for investment for children having a lock – in for at least 5 years or till the child attains age of majority (whichever is earlier).

Other Schemes

S. No.

Category of Scheme

Characteristics

Type of scheme

1

Index Funds/ ETFs

Minimum investment in securities of a particular index (which is being replicated/ tracked) – 95% of total assets.

A mutual fund replicating/ tracking any index.

2

Fund of Funds (Overseas/Domestic)

Minimum investment in the underlying fund – 95% of total assets.

A fund of fund is a mutual fund that invests in other mutual funds.

Impact on Investors

  • If the fund house discontinues any scheme, the investor will have to redeem and might as well have to pay taxes on capital gains.
  • To comply with new norms, funds might churn their portfolio to align with their category. For investors, it requires immediate review.
  • In the case of an NRI investor, TDS shall be deducted under the applicable tax laws, upon exercise of exit option and the same would be required to be borne by such investor.

Final Words

The new regulations on the categorization and rationalization of Mutual Funds by SEBI is a welcome move. It will benefit the investors to choose a fund according to their risk profile, compare similar funds from different AMCs easily, and there wouldn't be any need to worry about the risk of fund managers deviating from the norms.

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Ishita Jha is an MBA Finance student of BIMTECH, now a blogger; trying to survive the pandemic recruitments. She can be found researching, exercising, and binging to balance life. She finds her happy place in writing.

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