A Guide to SEBI’s New Categories of Mutual Fund
There are many new categories that SEBI has created after the recent reclassification of mutual funds.
Many new categories didn’t exist before this point in time.
The system that SEBI has now evolved has 36 categories of mutual funds.
The basic idea of categories is that one can divide funds into different buckets based on investment usage and characteristics.
With such a categorization, investors can first understand which category meets their investment needs and then evaluate only the funds that fit into that category.
One of the most important points in the circular is that different mutual fund schemes should be clearly distinct in terms of investment strategy and asset allocation.
The schemes will be broadly classified into the following schemes:
1. Equity Schemes: Will include schemes that will invest in equity and related instruments. SEBI has decided on a total of 10 categories under this scheme.
2. Debt Schemes: Will include investments in debt instruments. SEBI has decided a total of 16 categories under the debt scheme.
3. Hybrid Schemes: Will include investments in the mixed-equity, debt, and other assets. There are 6 categories under hybrid schemes as defined by SEBI.
4. Solution Oriented Schemes: Will include schemes like children’s savings or retirement schemes. These schemes have 2 categories of mutual funds.
5. Other Schemes: Will include index funds, funds-of-funds, and ETFs. These are having 2 categories.
There are many new fund categories introduced in the existing 36 categories but were trimmed down to only five schemes mentioned above.
Let’s look into the new fund categories introduced by SEBI in October 2017 circular.
New Mutual Fund Categories in Equity Schemes
SEBI has decided on a total of 11 categories under the equity scheme but a mutual fund company can only have 10 categories and it has to choose between Value or Contra. Still, 10 categories look a bit high but I think it is fair considering the possible variations in the strategy.
To make this easier SEBI has also defined the meaning of Large Cap, Mid Cap, and Small Cap.
- Large Cap: Top 100 companies in terms of market capitalization
- Mid Cap: 101st- 250th companies in terms of market capitalization
- Small Cap: 251st company onwards in terms of market capitalization
4 new categories of equity oriented were introduced by SEBI. These are:
1. Large & Mid Cap Fund Category
At present, some large-cap schemes carry a sizable chunk of mid-cap stocks in their portfolios.
Mid-cap funds straying into the large-cap territory is also common.
However, there are concerns that this ‘style drift’ puts investors at risk. That’s the main reason for introducing this new Large & Mid Cap equity fund category.
Key Details
| Scheme type | Equity scheme |
| Definition | An open ended equity mutual fund investing in both large cap and mid cap stocks of the Indian market |
| Asset allocation | Minimum investment in equity & equity related instruments of large cap stocks – 35% of total assets and mid cap stocks – 35% of total assets |
Investment Style
The ideal investing tenure for this category of mutual funds is 6 years.
Further, these funds are riskier than large-cap funds. The fund manager’s call can go completely awry. Analyze your risk appetite before investing.
2. Value Fund Category
Value funds are run with a clear emphasis on the tenets of value investing.
The focus is on identifying stocks that are currently priced at a discount to their intrinsic value or at a price that is not reflective of their true worth.
By buying a stock at a high margin of safety, the risk is mitigated to some extent while enhancing the return potential.
Key Details
| Scheme type | Equity scheme |
| Definition | An equity mutual fund following a value investment strategy |
| Asset allocation | Minimum investment in equity & equity related instruments is 65% of total assets |
Investment Style
There are only a handful of equity funds in the market which use the value investment strategy.
Value funds can underperform significantly during bull phases when value stocks go out of favour.
However, these tend to deliver healthy returns over the long-term by outperforming during a downturn or a range-bound market.
So, the best way to invest in this category of mutual funds is to have a long-term investment horizon of at least 5 years.
3. Contra Fund Category
As the name suggests, these funds take a contrarian view of equities.
The fund manager picks underperforming stocks or sectors, which are likely to perform well in the long run, at cheap valuations.
Mutual funds under the new SEBI circular will be permitted to offer either a Value fund or a Contra fund.
Key Details
| Scheme type | Equity scheme |
| Definition | An equity mutual fund following a contrarian investment strategy |
| Asset allocation | Minimum investment in equity & equity related instruments is 65% of total assets |
Investment Style
Financial planners suggest that individuals should look at this category as a diversification opportunity, that is, only after they have invested a significant portion of their mutual fund portfolio in large-cap, equity diversified funds. Even then, invest only 10-15% of your portfolio in these funds.
Remember, these funds invest in ‘out-of-flavour’ themes and, hence, may not perform in the short term.
Therefore, only those with an investment horizon of about up to 5 years should consider this option.
4. Focused Fund Category
While a majority of the fund managers prefer running a diversified portfolio, there are some who argue in favour of a focused portfolio.
A focused mutual fund focuses on a limited number of stocks in a limited number of sectors, rather than holding a diversified mix of equity positions.
Key Details
| Scheme type | Equity scheme |
| Definition | An equity scheme investing in maximum of 30 stocks (mention where the scheme intends to focus, viz., multi-cap, large cap, mid cap, small cap) |
| Asset allocation | Minimum investment in equity & equity related instruments is 65% of total assets |
Investment Style
In focused schemes, fund managers typically invest in 25-30 stocks identified as superior growth opportunities.
While a concentrated portfolio increases the odds of a strong performer having an outsized positive impact on the fund, it also enhances the impact of a loss-making investment.
This fund category, due to lack of diversification, comes with higher volatility and lower consistency in performance over the short term.
So, the best way to invest in this category of mutual funds is to have a long-term investment horizon of at least 5 years. The ideal investment tenure will depend on the market cap of the stocks chosen.
New Mutual fund categories in Debt schemes
SEBI has decided on a total of 16 categories under Debt Schemes. 16 categories are very high for debt funds considering their similarity in risk and returns from a retail investor perspective.
10 new categories of debt oriented were introduced and the rest 6 already existed. These new debt fund categories are:
1. Overnight Fund Category
Key Details
| Scheme type | Debt scheme |
| Definition | A debt scheme investing in overnight securities |
| Asset allocation | Investment in overnight securities having maturity of 1 day |
Investment Style
Risk-averse investors can consider parking their money in overnight mutual funds.
This is a type of debt fund with practically no interest rate fluctuation risk and credit rating risk and low credit default risk.
2. Short Duration Fund Category
Key Details
| Scheme type | Debt scheme |
| Definition | A short term debt scheme investing in instruments with Macaulay duration between 1 year and 3 years |
| Asset allocation | Investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is between 1 year – 3 years |
Investment Style
Duration measures the sensitivity of bond price to changes in interest rates and is measured in years. The higher the time duration, the riskier a bond investment is as bond prices fall with the rise in interest rates.
So, this is best for investors who are risk averse and want to invest a large corpus for a short time.
3. Medium Duration Fund Category
Key Details
| Scheme type | Debt scheme |
| Definition | A medium term debt scheme investing in instruments with Macaulay duration between 3 years and 4 years |
| Asset allocation | Investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is between 3 years – 4 years |
Investment Style
Debt funds are known for being less risky investment instruments. So if you are looking for an investment horizon of 3-4 years with the least risk, then this is the category for you to invest in.
4. Medium to Long Duration Fund Category
Key Details
| Scheme type | Debt scheme |
| Definition | A medium term debt scheme investing in instruments with Macaulay duration between 4 years and 7 years |
| Asset allocation | Investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is between 4 years – 7 years |
Investment Style
Risk-averse investors can consider parking their money for a long-term of 4-7 years can consider investing in this fund category.
5. Long Duration Fund Category
Key Details
| Scheme type | Debt scheme |
| Definition | A debt scheme investing in instruments with Macaulay duration greater than 7 years |
| Asset allocation | Investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is greater than 7 years |
Investment Style
This category of the fund is for those who want to invest for long-term (more than 7 years), without any risk and still earn returns better and bank FDs.
6. Corporate Bond Fund Category
Key Details
| Scheme type | Debt scheme |
| Definition | A debt scheme predominantly investing in the highest rated corporate bonds i.e, in instruments with the highest credit rating-AAA or equivalent |
| Asset allocation | Minimum investment in corporate bonds – 80% of total assets (only in highest rated instruments) |
Investment Style
The corporate bond fund category is a good choice for investors who are looking for a fixed but higher income from a safe avenue.
It is a low-risk investment vehicle, compared to other debt funds as it ensures capital protection.
7. Credit Risk Fund Category
Key Details
| Scheme type | Debt scheme |
| Definition | A debt scheme predominantly investing in below highest rated corporate bonds i.e, in instruments rated AA or lower |
| Asset allocation | Minimum investment in corporate bonds – 80% of total assets (only in below highest rated instruments) |
Investment Style
Credit-risk funds that invest in securities with lower ratings are gaining popularity among investors as there is a potential for investors to earn double-digit returns.
But Credit-risk funds have higher liquidity risks.
If a bond with a lower rating in the portfolio defaults or faces a further downgrade, it may be difficult for the fund manager to exit this holding.
So, investors should not hold more than 20% of their debt portfolios in such funds, which typically carry higher risk compared to other debt funds.
8. Banking and PSU Fund Category
Key Details
| Scheme type | Debt scheme |
| Definition | A debt scheme investing in overnight securities |
| Asset allocation | Investment in overnight securities having maturity of 1 day |
Investment Style
If you are looking for a debt fund to replace your bank deposits, here is an emerging class of debt funds that provides liquidity, carries low risk and volatility, and can generate reasonably stable returns – banking and PSU debt funds.
While the volatility in this class of funds can be expected to be low (as their average maturity is not high), do note that these funds too can sport negative returns on days when yields go up.
Since the bonds/debentures are all traded, when yields move up, mark-to-market losses are inevitable.
9. Gilt Fund Category with 10-year constant duration
Key Details
| Scheme type | Debt scheme |
| Definition | A debt scheme investing in government securities having a constant maturity of 10 years |
| Asset allocation | Minimum investment in Government securities – 80% of total assets such that the Macaulay duration of the portfolio is equal to 10 years |
Investment Style
Some retail investors mistakenly believe that Gilt Funds are risk-free investments as they invest in Government securities.
While the Government securities themselves are risk-free with respect to interest and principal payments, the price of the securities fluctuates with changes in the yields or interest rates.
Gilt funds are in fact the riskiest product class among all debt funds in the short term.
so, the best way to invest in this category of mutual fund is to hold till maturity.
This is also known as the accrual strategy, by which the fund invests in certain types of fixed income securities (or bonds) and holds them till the maturity of the bond, earning the interest offered by the bond over the maturity period.
10. Floater Fund Category
Key Details
| Scheme type | Debt scheme |
| Definition | A debt scheme predominantly investing in floating rate instruments |
| Asset allocation | Minimum investment in floating rate instruments – 65% of total assets |
Investment Style
Funds in this category should invest in money market instruments with a maturity of up to 1 year and thus will be on par with today’s ultra short-term funds in terms of risk and return potential.
So, Float funds are a good option when interest rates are expected to rise.
When interest rates threaten to rise, investors start thinking about how they can prevent capital loss to their portfolios. In such a situation, floating rate funds can be attractive options.
New Mutual fund categories in Hybrid schemes
SEBI has decided a total of 7 categories under Hybrid Schemes but a mutual fund company can only have 6 categories and they have to choose between Balanced Hybrid Fund or Aggressive Hybrid Fund.
2 New categories were introduced to hybrid schemes and these are:
1. Multi Asset Allocation Category
Key Details
| Scheme type | Hybrid scheme |
| Definition |
A scheme investing in 3 different asset classes
|
| 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 |
Investment Style
The idea of investing across investment classes looks appealing and you may think that will address your problem of diversification of the portfolio and asset allocation. But that need not be the case always.
The fund manager decides the allocation of each asset class, taking into account various parameters such as valuations and macroeconomic factors.
2. Equity Savings Category
Key Details
| Scheme type | Debt scheme |
| Definition | A scheme investing in equity, arbitrage, and debt |
| Asset allocation | Minimum investment in equity & equity related instruments – 65% of total assets and minimum investment in debt – 10% of total assets. Minimum hedged & un-hedged to be stated in the SID. Asset Allocation under defensive considerations may also be stated in the Offer Document |
Investment Style
From a utility point of view, conservative investors trying to seek income from their investment and not wanting to assume great risk (even of the type found in balanced funds) should look at them.
These are desirable funds for conservative investors seeking reasonable returns with great stability.
Conclusion
Ultimately it is about the allocation of your money to the various investment categories i.e. equity, debt, and alternates. Through mutual funds, you anyway have to allocate to equity and debt, through multiple funds.
When the funds are undergoing rationalization with a broadly similar mandate, what is required of you is awareness and review of what is happening. You should exit a fund and re-allocate only when there is a sustained underperformance or a drastic change, called a change in the fundamental attribute, if it does not suit you.
It is a matter of time to find out the real outcome and performance of funds, and how investors will rate it.
Happy Investing!
Disclaimer: The views expressed here are of the author and do not reflect those of Groww.