Changes in Mutual Fund Rules Effective in 2021

One of India's largest asset management companies (AMC), Franklin Templeton Mutual Fund, on April 23, 2020, made an announcement that shook the entire mutual fund and its investor community. Franklin, in its announcement, declared the winding up of six of its debt funds. 

An announcement like this one was a never-seen-before moment. Frantic discussions arose on what it means and how it affects the investors.

To curb this franticness, SEBI issued a slew of guidelines and measures to improve the transparency in the operations of the mutual funds. These guidelines and measures seek to protect investors' interests by making mutual fund houses more accountable for their actions.

A look into some of the latest guidelines and measures issued by SEBI:

• Mutual funds handle at least 10% of their total secondary market trades by value (excluding trades on inter-scheme transfers) in commercial papers/corporate bonds through the one-to-many mode using the Request for Quote (RFQ) platform provided by the stock exchange. 
   
• Debt schemes to make a fortnightly portfolio disclosure within five days of every fortnight. 
   
• Mutual funds to make a daily disclosure of the details of the scheme's transactions in a comprehensive format with an allowed time lag of 15 days. This time lag is lower compared to the previously permitted lag of 30 days. 
   
• SEBI has allowed mutual funds to create side-pockets in debt restructuring events. This measure is introduced to prevent the Net Asset Value (NAV) from taking a hit.

2021 Mutual funds Rules - A step towards better transparency:

The money matters of investors and their investments will see significant changes in 2021. These significant changes range from writing cheques and swiping off credit cards to the way of making investments in mutual funds.

Today, we discuss the new rules that become applicable to mutual fund investments from 2021.

Let's get started!

Guidelines regarding the new Risk-o-Meter:

SEBI has been persistent in its advice to the fund houses to stick to the labels and urged them to convey the risks involved in a particular scheme as well as the category. With this in mind, in October 2020, SEBI issued revised guidelines for product labelling of mutual fund schemes. These guidelines apply to all the existing and upcoming schemes.

Previously, mutual fund schemes were classified into five risk levels. They were:

1. Low-risk

2. Moderately low-risk

3. Moderate risk

4. Moderately high-risk

5. High-risk

Under the revised guidelines, SEBI has introduced a sixth risk level – very high-risk.

Additional directions in the revised guidelines require the mutual fund houses to conduct a process of risk-labelling at the 'scheme-level' instead of the earlier process of doing it at the 'scheme-category level.' 

Therefore, if all the mutual fund houses classified their equity schemes in the high-risk category under the previous system, they will reclassify the schemes differentiating them depending on their portfolio attributes.

Tightening of the inter-scheme transfer norms:

With the revised guidelines, SEBI has tightened the norms on inter-scheme transfer (IST) of the bonds. The new norms are put forth so that the IST transactions do not expose the transferee schemes to any unwarranted risks. 

IST is only permitted if the transfers are done at the prevailing market price for quoted instruments on a spot basis. When this is done, the securities transferred conform with the scheme's investment objective to which such IST has been made.

SEBI also made the following safeguarding guidelines:

1. Close-ended schemes will be permitted IST purchase transactions only within three days of allotment in pursuance of the New Fund Offer (NFO), and no ISTs will be allowed to and from these schemes after that.

2. Open-ended schemes, under the following circumstances, will be allowed ISTs:

a) In case of any unanticipated redemption pressure, an open-ended scheme can opt for IST provided there is remains some scheme level liquidity deficit after using the following measures:

    i. Utilization of scheme cash and cash equivalents

   ii. Utilization of market borrowing

   iii. Selling of securities in the market

b) IST will be permitted for rebalancing provided that the balancing is required in both the transferor and transferee schemes. Rebalancing is done to meet the regulatory limits relating to duration, issuer, sector, and group. The fund managers' performance incentive and chief investment officers will be negatively affected if the credit schemes' security is assigned a default grade within one year of the IST.

Renaming of the dividend option:

SEBI has directed the mutual fund houses to rename the dividend option based on the recommendations of the Mutual Funds Advisory Committee (MFAC). The mutual fund houses will follow the following naming conventions:

SEBI has emphasized the need for clear communication with the investor that a certain portion of their capital (Equalization Reserve) under the dividend option of a mutual fund scheme can be distributed as dividends.

All mutual funds will now disclose the amount that can be distributed out of equalization reserve representing realized gains in their offer documents. Fund houses will disclose this information to the investors at the time of investing in such options.

Under the new guidelines, fund houses will also maintain clear segregation between income distribution (appreciation in NAV) and capital distribution (equalization reserve) in a consolidated account statement, which will then be provided to the investors.

True to label multi-cap funds:

In order to ensure that the portfolio held by multi-cap funds is diversified across large, mid, and small-cap companies and to distinguish the same clearly from schemes of other categories, SEBI has partially modified the features of multi-cap funds.

Under the new regime, multi-cap funds will now invest at least 75% of their total assets in equities. They will have at least 25% exposure in large-cap, mid-cap, and small-cap company stocks. This contrasts with the earlier norms where multi-cap funds were mandated to invest a minimum of 65% of their assets in equity and equity-related instruments with no limit on market cap allocation.

An option to rebrand the multi-cap scheme as a Flexi-cap scheme is available to fund managers apprehensive about the portfolio's reshuffling or the idea of merging with other schemes. Flexi-cap scheme is a new category under equity schemes that can dynamically allocate its assets across market capitalization.

Changes in the calculation of NAV:

With effect from January 1, 2021, the investors will purchase NAV of the day when the AMC receives the investor money. This is irrespective of the size of the investment. The changed method of NAV calculation will apply to all schemes except liquid and overnight funds. The closing NAV of the day shall be applicable on which the funds are available for utilization irrespective of the size and time of receipt of such application.

The Bottom Line  

Time and again SEBI undertakes bold steps and issues rules and guidelines to shape and transform the mutual funds industry. The rules we discussed today are a positive step towards improvement in the transparency in the operations of the mutual funds. 

How well these rules are received by the mutual fund houses, only time will tell.

Stay Positive, Test Negative!

Happy Investing!!