Funds need to adapt quickly to new Sebi rules
Investors are the biggest beneficiaries of this change as they can now compare schemes and make informed decisions
The biggest global sporting extravaganza—the FIFA world cup—is on and what a group stage it was: Croatia defeated Argentina; Mexico beat Germany; Japan beat Colombia, and defending champions Germany did not even qualify for the knock-outs. Things can change in an instant; and success lies in being able to adapt. Demonetisation and GST implementation are recent examples of such events. The latest such change that the mutual funds industry has to weather is product categorisation by Securities and Exchange Board of India (Sebi).
The exponential growth of the industry over the past few years has also been coupled with a proliferation of products, often without sufficient differentiation, and in some cases, purely driven by AUM (assets under management) considerations. The lack of standard definitions and lack of a consistent “true to label” mindset was another challenge. Investors had plenty of choices, with 830 open-ended funds as of October 2017. Sebi had expressed displeasure with the multiplicity of “me-too” products, and it finally acted by asking fund houses to classify schemes as per standard product category definitions and restricted them to just one product per category. While potentially disruptive for some, this was a big reaffirmation for asset managers with a limited but well-diversified product suite whose funds stuck to their mandate, even in challenging times.
As per the Sebi circular, all open-ended schemes were classified under five broad groups: equity, debt, hybrid, solution-oriented and others (index, exchange-traded funds or ETFs and fund of funds or FoFs). There were 10 categories specified for equity funds (based on market-cap orientation and investment style), 16 for debt funds (by portfolio duration, type of securities and credit risk), six for hybrid funds (by asset class mix) and two each for solution-oriented and other fund groups. The definitions specified the exact asset and risk allocation for each scheme type. Index funds, ETFs, FoFs and sectoral or thematic funds were exempted from the one product per category limit.
Post implementation, the changes ranged from simple fund name changes to portfolio changes to funds that were wound up and merged with others. Given the scale of the exercise, it will take some time for advisers to become familiar with new fund names and categories. But what is more critical is for advisers and investors to understand what has truly changed. Advisers must insist on detailed pre- and post-rationalisation portfolio disclosures from asset managers, and consider whether past performance as an evaluation criteria still holds good. This is a case of caveat emptor—where a fund has undergone significant portfolio changes or merged, past performance may not be relevant.
Investors are the biggest beneficiaries of this change as they can now compare schemes and make informed decisions. Standardised classification will help them understand the risk-return trade-off across their holdings with greater clarity. For example, a large-cap equity fund must now invest at least 80% of its portfolio in large-cap stocks and cannot change its mandate by adding more mid-cap stocks to boost performance. Further, debt funds are now categorised as corporate bond, credit risk, dynamic bond and banking and PSU funds wherein a corporate bond fund cannot take additional risks of investing in lower rated bonds, which are now the domain of credit risk funds.
I would, however, add a note of caution (good intentions of the regulator notwithstanding). First, we must ensure future innovation is not stifled. I say this because, many of today’s popular product categories did not even exist a few years ago. Further, an unintended risk is that restrictions in the open-ended space may cause assets to move to structures such as closed-end funds and portfolio management services, which may not always be in the investor’s best interest. Second, while standard categories are welcome, category names like “credit risk funds” may give the impression that only credit funds carry risk, and other fixed income funds do not. Third, while Sebi has standardised the disclosure of historical returns of erstwhile schemes in case of mergers, it would help if this is extended to schemes undergoing significant changes as their historical returns may not be strictly comparable to their potential for future returns.
Only eight teams have won the FIFA World Cup since the tournament began in 1930. Will a ninth team win in Russia? One thing's certain; the team that is nimble and responds to change quickly will be victorious. The mutual fund industry must be equally responsive.
Sanjay Sapre is president, Franklin Templeton Investments, India
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