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 usages 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.

Read more: Impact on Investors: Categorization and Rationalization of Existing Mutual Funds

One of the most important points in the circular is that different mutual funds schemes should be clearly distinct in terms of investment strategy and asset allocation.

The schemes will be broadly classified into following schemes:

1.Equity Schemes: Will include schemes that will invest in equity and related instruments. SEBI has decided total 10 categories under this scheme.

2.Debt Schemes: Will include investments in debt instruments. SEBI has decided total 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 define by SEBI.

4.Solution Oriented Schemes: Will include schemes like children 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 category introduced in existing 36 categories, but were trimmed down to only five schemes mentioned above.

Lets look into the new fund categories introduced by SEBI in October 2017 circular.

In this article

New Mutual Fund Categories in Equity Schemes

SEBI has decided a total of 11 categories under equity scheme but a mutual fund company can only have 10 categories and it has to choose between Value or Contra. Still, 10 categories looks bit high but I think its fair considering the possible variations in the startegy.

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 term 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 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

Ideal investing tenure for this category mutual funds is 6 years.

Further, these funds are riskier than large cap funds. The fund manager’s call can go completely awry. Analyse your risk appetite before investing.

Best Large and Mid Cap Funds for 2018:

1. Principal Emerging Bluechip Fund

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 favor.

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.

Best Value Funds for 2018:

1. Aditya Birla Sun Life Pure Value 

2. IDFC Sterling Value Fund

3. HDFC Capital Builder Value Fund

3. Contra Fund Category

As the name suggests, these funds take a contrarian view on 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 new SEBI circular will be permitted to offer either Value fund or 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-flavor’ 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.

Best Contra Funds for 2018:

1. Invesco India Contra Fund

2. Kotak Classic Contra

4. Focused Fund Category

While a majority of the fund managers prefer running a diversified portfolio, there are some who argue in favor of a focused portfolio.

A focused mutual fund focuses on a limited number 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 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 stocks chosen.

Best Focused Funds for 2018:

1. Axis Focused 25 Fund

2. SBI Focused Equity Fund

3. IDFC Focused Equity Fund

New Mutual fund categories in Debt schemes

SEBI has decided total 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 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.

Best Overnight Funds for 2018

1. HDFC Overnight Fund

2. UTI Overnight Fund

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. 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 large corpus for short time.

Best Short Duration Funds for 2018

1. HDFC Short Term Debt Fund

2. Franklin India STIP

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 least risk, then this the category for you to invest in.

Best Medium Duration Funds for 2018

1. Franklin India Income Opportunities Fund

2. SBI Magnum Medium Duration Fund

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 long-term of 4-7 years can consider investing in this fund category.

Best Medium to Long-Duration Funds for 2018

1. ICICI Prudential Bond Fund 

2. UTI Bond Fund

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 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.

Best Long Duration Funds for 2018

2. IDFC Bond Fund – Long Term Fund 

6. Corporate Bond Fund Category

Key Details

Scheme type Debt scheme
Definition A debt scheme predominantly investing in 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

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.

Best Corporate Bond Fund for 2018

1. Aditya Birla Sun Life Corporate Bond Fund

2. ICICI Prudential Corporate Bond Fund

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 a higher liquidity risk.

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 mutual fund is to hold till maturity.

This is also known as accrual strategy, by which the fund invests in certain types of fixed income securities (or bonds) and hold them till 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, Floater 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 portfolio. In such a situation, floating rate funds can be attractive options.

Best Floater Funds for 2018

1. JM Dynamic Debt Fund

2. Aditya Birla Sun Life Floating Rate Fund

New Mutual fund categories in Hybrid schemes

SEBI has decided total 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 look 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 of the asset class, taking into account various parameters such as valuations and macroeconomic factors.

Best Multi-Asset Allocation Fund for 2018

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.

Best Equity Savings Funds for 2018

1. Aditya Birla Sun Life Equity Savings Fund

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.