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How standardised fund categories help investors follow investing best practices

Re-categorisation of mutual funds under SEBI’s directive has implications on the way funds will manage investors’ money. This has an impact on our portfolio construction and fund selection algorithm.

Re-categorisation of mutual funds under SEBI’s directive has implications on the way funds will manage investors' money. This has an impact on our portfolio construction and fund selection algorithm.

Background

SEBI issued an important notification in October 2017, which required Mutual Fund Companies to categorise every mutual fund under one of 36 well defined categories. The category definition makes very clear the kind of investments that a mutual fund in that category can make. In addition SEBI specified that a mutual fund company can have only one mutual fund in each category.


Please refer this article for a more detailed list.

Standardisation is designed to improve investing

This standardisation led to a number of changes in the way each fund is managed.

  • Names of each fund have been aligned to the classification, so that investors can understand each fund well based on just the name.
  • If the mutual fund company had more than one mutual fund with similar investments, the funds were merged.
  • Every fund has to clearly define its objective in line with the category mandate, and adhere to it.
  • Funds had to make changes in the kind of stocks they held - for example: mix of large, mid and small cap stocks; in line with their new objectives. There is very little flexibility for the fund manager to have exposure to stocks outside the size buckets for a mutual fund category.

The changes were significant and took a while to be put in place. Over the last quarter every mutual fund company has complied with SEBI’s directive.

What does this mean for you?

This is an important change for investors in Mutual Funds, and also a sign of growing maturity of the Indian equity markets. With clear definition of what a mutual fund does, an investor can now follow a portfolio construction approach similar to one adopted in developed markets:

  1. Plan for the right mix of mutual funds across various size buckets and other strategies.
  2. Identify the best fund(s) which follow the chosen investment strategy.

For example: an investor planning to accumulate wealth over the long term by investing in equity can now construct a portfolio of 50% large Cap & 50% mid cap. Another can follow 30% large cap, 30% midcap and 40% into other diversified strategies such as value funds. They can then choose mutual funds that accurately follow these category mandates. The portfolio strategy can then be expected to deliver the outcome that the investor has planned for.

What is Scripbox doing for you?

Going forward, Scripbox will follow a 3 step approach (instead of earlier 2 step approach) to recommending investments:

  1. Determine a suitable asset allocation based on the objective of the investor: For example, long term wealth creation could provide for x% Equity, y% fixed income (debt)
  2. Determine a portfolio construct for each asset class, based on benchmark data for each sub-asset class: For example: Equity asset class should comprise of n%large cap, m% mid cap, etc
  3. Determine a basket of funds that best represents the sub-asset class by
  4. a. Mapping categories of funds to sub-asset class; and
    b. Applying our fund selection rules which evaluate consistency of performance against the sub-asset class benchmark.

Specific approach for Long Term Wealth

  1. Asset Allocation: We are continuing to recommend a 100% equity allocation the Long Term Wealth objective.
  2. Portfolio Construct: For the Equity allocation, we are recommending 2 sub-asset classes: 50% large cap and 50% diversified strategy.
  3. Basket Recommendation: We are recommending 2 funds for large cap and 2 funds for diversified.
  4. a. Large Cap Equity sub-asset class is mapped to Large Cap Equity Funds category
    b. Diversified Equity sub-asset class is mapped to the universe of 6 different equity fund categories -
    1. Multi Cap Fund
    2. Large & Mid Cap Fund
    3. Dividend Yield Fund
    4. Value Fund
    5. Contra Fund
    6. Focused Fund

Reference: Summary of SEBI categories for mutual funds

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