Please note that our servers will be under maintenance on 19th December 2018 from 7pm onwards, for approximately 2 - 4 hours. During this time the website will be unavailable. We regret for the inconvenience. Thank you for your support. Regards, Team PersonalFN.

SEBI’s New Circular On Mutual Funds -- What Does It Means For Your Investments   Dec 06, 2017

compass The Securities and Exchange Board of India (SEBI)  issued new norms in October 2017 to rationalise the process of classification of mutual fund schemes. Initially, mutual fund houses agreed with this decision, but changed their stance when they realised the difficulties in implementing the changes suggested by the capital market regulator. In response, the industry body—Association of Mutual Funds in India (AMFI) made representation to SEBI requesting amendments to the newly issued rules.

Taking a note of issues raised by the mutual fund industry and realising the practical difficulties in the implementation, SEBI amended the classification norms recently.

 As per the original circular issued by the capital market regulator, equity-oriented schemes were to follow the rules below:

  • Large-cap oriented schemes should invest at least 80% of their assets in large cap stocks
  • Large-cap 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 were 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

In the original circular, SEBI directed mutual funds to adopt the list of stocks the AMFI had prepared that classified them as large caps, mid caps, or small caps. Further, SEBI advised AMFI to adhere to the following points while preparing the list:

  1. If a stock is listed on more than one recognized stock exchange, an average of full market capitalization of the stock on all such stock exchanges, will be computed;
  2. In case a stock is listed on only one of the recognized stock exchanges, the full market capitalization of that stock on such an exchange will be considered.
  3. This list would be uploaded on the AMFI website and it will be updated every six months based on the data as of on the end of June and December of each year. The data shall be available on the AMFI website within five calendar days from the end of the six months period.

Mutual fund houses argued that, these norms would potentially limit their choices while picking stocks for the portfolio. Moreover, some fund managers opined that the new norms will make them take higher risks.

In the amended version of mutual fund classification rules, SEBI offered some concession by adding an additional point to the list above. The new circular says, “While preparing the single consolidated list of stocks, average full market capitalization of the previous six month of the stocks shall be considered.”

What are the Implications of SEBI’s mutual fund circular

Nothing will change significantly since the amendment, in this regard, won’t be considered in isolation, but will be an addition to the original provisions. Thus, it will only offer some more reaction time to the fund manager if any market movement disqualifies fund manager’s stock selection.

Consider this example. The fund manager of a mid-cap oriented scheme bought 10 stocks about two years back which, due to market movement, have become large caps now and are resulting in the fund violating categorisation norms. Since the new amendments require AMFI to consider average market cap of last six months, the fund manager will not be stressed to sell them immediately.  

Conversely, a large cap fund can make investments in such stocks only with a lag effect—this saves it from further flip-flops in buying and selling, which, in a way, is a forced decision made to comply with the classification norms.

Amendments in the provisions governing debt funds…

In the case of  ultra-short term duration, short duration, low duration, medium duration, medium to long duration, and long duration schemes, the ‘duration’ shall be considered at the portfolio level and not at the individual security’s level. Further, SEBI insisted on fund houses readily disclosing the indicative duration of the portfolio in the following manner.

 “An open ended XYZ scheme investing in instruments such that the Macaulay duration of the portfolio is between A to B years.”

Moreover, fund houses are also required to explain the concept of duration and provide more information on it in the offer document. For medium duration funds and medium to long duration funds, the fund houses will have to mention tentative duration profile of such offerings under adverse market conditions. In this context, they will also have to note the reasons for deviating from the stated duration strategies, as and when they do.

For example, indicative allocation of a medium duration fund will have to make in the following manner.

Investment in debt and money market instruments will be made in such a way that the Macaulay duration of the portfolio is between 3 to 4 years. Portfolio Macaulay duration under anticipated adverse situation is 2 year to 4 years.

The amendments have allowed corporate bonds funds to invest at least 80% in corporate bonds with a credit rating of AA+ and above. In the original circular, they were advised to invest at least 80% of their assets only in the corporate bonds of the higher credit rating.

Similarly, credit risk funds can now invest at least 65% of their total corpus in corporate bonds rated AA and below (excluding AA+ rated instruments). Earlier, they were required to invest minimum of 65% of assets in bonds below the highest credit ratings.

With the amendments, banking and PSU funds are allowed to invest in municipal bonds as well; previously, they weren’t. Moreover, floater funds can now invest in floating rate instruments by taking exposure using derivative instruments.

To sum up…

Amendments to the rules dealing with the categorisation and the rationalisation of schemes will offer flexibility to the fund houses. While fund managers enjoy more leeway in portfolio management, managing risk has become an even more critical function for the mutual fund houses.

Greater disclosure norms, especially in case of debt funds, will make it easy for investors to select a fund.

If you are unsure about which schemes you should invest in, we strongly suggest you subscribe to PersonalFN’s FundSelect Plus ------ comprehensive portfolio service ------ and benefit from the SEVEN time-tested, readymade equity and debt mutual fund portfolios. Based on your risk profile and investment horizon, you can choose out of three equity portfolios and three debt portfolios. In addition, you get a readymade tax-saving portfolio as well.

Get quick access to the 7 high-performing, time-tested readymade portfolios with a decade-long market-beating track record. Don’t miss out on exclusive discounts available and Subscribe Now! 

Add Comments