By Sanket Dhanorkar, ET Bureau|Updated: Oct 16, 2017, 11.20 AM IST
The Securities and Exchange Board of India (Sebi) has asked fund houses to classify their schemes into clearly defined categories. For long, there were no clear guidelines to categorise mutual funds. Fund houses even launched multiple schemes under each category, making scheme selection a confusing exercise for investors. To introduce clarity, Sebi has now asked fund houses to have just one scheme per category, with the exception of index funds, fund of funds and sector or thematic schemes.Mutual funds which have multiple products in a category will have to merge, wind up, or change the fundamental attributes of their products.
Simplification of choice, fewer options
At the broadest level, mutual funds will now be classified as equity, debt, hybrid, solution-oriented, and ‘other’. Equity schemes will have 10 sub-categories, including multicap, large-cap, mid-cap, large- and mid-cap, and small-cap, among others. The stocks of the top 100 companies by market value will be classified as large-caps. Those of companies ranked between 101 and 250 will be termed mid-caps, and stocks of firms beyond the top 250 by market cap will be categorised as small-caps. Debt and hybrid schemes will similarly be grouped into 16 and six sub-categories respectively.
In particular, people interested in debt and hybrid schemes will now be better placed to identify the right schemes. For instance, duration funds have been segregated into four sub-categories, based on the maturity profile of the instruments they invest in. Debt funds belonging to the broader ‘income funds’ category will now be identified as dynamic bond fund, credit risk fund, corporate bond fund, and banking and PSU fund, based on their unique characteristics. Similarly, segregation of hybrid funds—based on their equity exposure—as aggressive hybrid, conservative hybrid and balanced hybrid, will allow investors to better identify the type of hybrid fund they want to invest in.
“Now that scheme labelling is clearly linked to a fund’s strategy, the investor will clearly know what he is getting into. The fund category will define the scheme, and not its name,” says Kunal Bajaj, CEO, Clearfunds. Fund houses will also not be allowed to name schemes in a way that only highlights the return aspect of the schemes— credit opportunities, high yield, income advantage, etc.
Adherence to fund mandate
With strict classification of schemes, fund houses may not be able to alter the investing style or focus of their schemes, as they did earlier. For instance, mid-cap funds stray into the large-cap territory or across market caps, in response to market conditions, which dramatically alters their risk profile. Now, funds will be forced to maintain their investing focus. Any drastic change in style will constitute a change in the fundamentalattributes of the scheme, which would have to be communicated to the investors. For investors, this means they won’t have to worry about their chosen schemes altering mandates to something which doesn’t suit their needs or risk profile.
Better comparison with peers
Distinct categorisation of schemes will also enable a better comparison of funds within the same category. While the earlier largecap funds category had schemes with pure large-cap focus as well those with a sizeable mid-cap exposure, now such distinctly varied schemes won’t be clubbed together. This will further help investors identify the right schemes by facilitating a like-for-like comparison of funds. “All schemes of different AMCs within a similar category will have similar characteristics, which will enable customers to make a better ‘apples to apples’ comparison,” says Stephan Groening, Director, Investment Solutions, Sharekhan, BNP Paribas.
These schemes may be reclassified or merged
The new Sebi norms require funds to have only one scheme per category.
Note: This is only an indicative list. All schemes mentioned may be retained by the respective fund house. There may be other duplicate schemes from other fund houses also. Source: Value Research.
Sharp rise in fund corpus
Since fund houses will now be forced to merge duplicate schemes within the same categories, it may sharply increase the size of certain funds. This could hurt the scheme’s performance. “Some larger fund houses with multiple schemes will have to opt for mergers. This may lead to a sudden, sharp rise in the corpus of schemes, which could dent the fund’s returns,” says Vidya Bala, Head, Mutual Fund Research, FundsIndia. “There could also be an impact cost on the investor, as fund may rebalance or churn the portfolio to ensure the fund aligns with the category norms,” adds Bala. For instance, both HDFC Balanced and HDFC Prudence are aggressive hybrid funds, with a corpus of Rs 14,767 and Rs 30,304 crore. Merging the two will create a Rs 45,000 crore fund. However, it is more likely that the fund house may instead reposition one of the schemes in another category.
Possible fall in outperformance
While the new norms are likely to lead to better adherence to the fund style and mandate, it may result in reduction in alpha—outperformance compared to the index—for some schemes. Funds often tend to stray away from their chosen mandate in the pursuit of generating excess return over the benchmark index. Now, with limited flexibility to stray into another segment, some funds may find alpha generation more difficult than before, reckons Bala.
Need for portfolio review
Since fund houses will now have to align their product suite with these norms, there is likely to be a flurry of activity related to recategorisation of funds. In order to avoid merging certain duplicate schemes, these are likely to be renamed or reclassified into another fund category. Some funds may witness a change in scheme attributes to facilitate its repositioning. As such, over the next 5-6 months, several schemes may change colours. Investors would then have to undertake a thorough portfolio review to ensure their funds continue to meet their requirements, insists Bajaj.
TIMESOFINDIA.COM | Sep 1, 2017, 12:36 IST
You can invest in mutual funds with amount as low as Rs 500. There is no upper limit for investing in mutual funds. Each mutual fund – be it equity or debt – has certain risk due to volatility and uncertainty in market. Ideally, you should be investing 10-20 per cent of your savings in mutual funds through monthly SIP.
Here are few points that you should keep in mind while investing in a debt or equity oriented schemes:
List down all your short-term and long-term goals in future such as holiday, marriage, children, education of children, retairment etc. Invest more into equities for your long-term needs as it is greatly possible to be aggressive in such cases. For your short-term needs, mutual funds with 1 year lock in can be adopted.
2) Risk capacity
The amount of investment risk you are able to take on is generally determined by your financial condition. Sudden financial shocks such as job loss, an accident etc. can affect your investment decisions by altering the amount of risk you’re able to afford. Your financial commitments such as home loan, business loan, car loan, expenditure in kids education etc. may also affect your investment risk capacity.
When it comes to investing, age is as big factor as the other two mentioned above. The best time to start investing is when you are young. The best time to learn about the markets and how to deal with its risks is when you’re young. Young investors have decades before they need the money. They have more time for their investments to recover and make up the shortfall. Once you are into your 30s and 40s, allocate a greater fraction of your portfolio to minimal risk funds or long-term funds. Also allocate some money to equity funds for your aggressive goals.
4) Fund selection – debt or equity
Debt funds can give you steady returns but in a constant range. Since debt funds invest money in treasury bonds, there’s much less risk associated with them. Debt funds are good investment option when market is volatile. Equity mutual funds give good returns over the long period to time as compared to debt funds. However, the possibility of losses and negative returns is also higher when market is volatile. Equity funds are good when the markets are booming.
You may also consult financial experts before taking final decisions. Mutual fund agents and distributors can also help you in this regard.
While debt funds, unlike fixed deposits and small saving schemes are also subject to market risk, though less than equity funds, the return expectation is commensurately higher than traditional products over the same tenure.
Kirtan Shah | Aug 24, 2017 10:19 AM IST | Source: Moneycontrol.com
Lately I have been meeting a lot of relatives, friends & acquaintances, grappling about a common concern of what to do now with the new normal of low interest rates on fixed deposits & small saving schemes. It is very disturbing for many because of their investment style and return expectations from the past. Invest in mutual funds, I said. ‘Don’t mutual funds invest in stocks?’, ‘Aren’t mutual funds risky?’, ‘Will I get fixed returns?’ they asked. Mutual Funds as a product offering which can invest in equity, debt, commodities and even a combination of them depending on the objective of the fund and hence investors across risk profiles, goals & time horizon will find a suitable product, I said.
Why Debt Funds
(1) Tenure of investment – Regardless of your time horizon, there is a suitable debt mutual fund available.
(2) Tax Efficiency – This is the reason why most FD investors will appreciate debt mutual funds. If you invest for less than 3 years, the gains are taxed at the income tax slab rate like in an FD but if you hold the investment for more than 3 years, the gains are taxed at 20% (even if you are in the 30% tax bracket) and that too not on the full gains but only on the gains that exceed inflation. So if you earn 8% on the debt fund and inflation (measured by CII) increases by 5% in the same period, you pay 20% tax only on 3% (8%-5%), which is 0.6% (20%*3%) versus 2.4% (8%*30%) 4 times higher in an FD investment. The post tax return on a debt mutual fund is far superior to a FD, even when we are assuming that the debt fund will generate returns similar to the traditional products.
(3) Possibility of higher returns – Return is a function of calculative risk taken. It is not that FD does not have any risk. It is presumed to have no risk, which may not be entirely true.
Let me highlight a couple of risks that all fixed income instruments have.
(a) Interest Rate Risk – Lets assume you have invested in a FD paying 7.5% return over 3 years. What if interest rates in the market move up? The same institutions will then pay 8% to the new depositor vs you still receiving 7.5%.
(b) Reinvestment Risk – In the same case above, if the interest rate moves down, you will get a lower rate from the same institution, when you try and reinvest after 3 years. This is the challenge most traditional product investors are currently facing and will continue to face in the future. Over the last 15 years, investors have seen bank FD’s paying as high as 12% as well but the average over the last 15 years is 8.5% on the bank FD.
(c) Inflation Risk – While the above investment matures after 3 years, you realize that inflation has moved up by 5% in the same period. The net result on your investment is not 7.5% but only 2.5%, which we call as the real rate of return. Most of the times you will observe that inflation is increasing at a pace faster than the returns offered on the FD, generating negative real return.
All the above are risks that one has to take irrespective of the fixed income instrument they invest in. While debt funds, unlike fixed deposits and small saving schemes are also subject to market risk, though less than equity funds, the return expectation is commensurately higher than traditional products over the same tenure. In the below chart you will see how various debt fund categories have performed over the last 3 years.
Risks in a Debt Mutual Fund
Interest Rate Risk – Debt funds invest in various fixed income instruments issued by the government, banks & financial institutions, RBI, corporates etc., which are mostly traded on the exchange helping the fund to generate higher returns over the interest (coupon) committed. The price of the traded fixed income instrument is inversely proportional to the market interest rate. Lets say the debt fund bought a government bond paying a coupon (interest rate) of 8% and is now trading in the market. In the future when interest rates drop, government would issue a new bond at a lower interest rate, say 7.5%. Everything else kept constant, it’s logical to buy the old listed bond, which pays higher interest rate of 8% than the new bond and hence the price of the old bond increases because of higher demand, generating capital gains for the debt fund over and above the 8% coupon. Interest rate risk in the bond fund is captured by modified duration. Higher the modified duration, higher is the risk and higher are the return expectations. If a fund has a modified duration 2, it means for every 1% drop in market interest rate, the debt fund will generate positive 2% returns over and above the YTM (investors can understand this as the coupon/interest rate). The table below will help you understand the interest rate risk profile of various debt funds.
Conclusion – If you want to take lower risk, select funds with lower modified duration.
Credit Risk – The fixed income instruments in which the debt funds invest are credit rated. Credit rating agencies give a rating to all these instruments showcasing the credit worthiness of the issuer to pay interest and return the principal. Higher the credit rating, lower the risk and hence lower is the coupon the issuer pays and vice versa. So let’s say, if the debt fund buys an instrument, which is highly credit rated at AAA, fund will receive a lower coupon rate, as the risk is low. Unfortunately, in the future if the credit rating agency reduces the credit rating to AA, the debt fund will still receive the same coupon that was committed earlier but the risk has increased and hence this fixed income instrument will start trading at a lower price on the exchange, incurring capital loss to the debt fund. The inverse is also true. The point to be noted is that the capital loss is only notional. If the debt fund does not sell the fixed income instrument in the market and continues to hold, it still receives the coupons committed as normal. The table below will help you understand the credit risk profile of various debt funds.
Conclusion – To reduce the risk, select funds, which invest in high credit rated products.
The right debt fund for you
The answer to which debt fund you should invest in, depends on your goal and risk profile. If your investment horizon is less than 3 months, the most ideal option is investing in a liquid fund. Having said that, you can invest in any other scheme from the list below, but the risk profile of the fund may increase if invested for less than the ideal investment horizon. Lets say you choose to invest in corporate bond funds for 3 months to generate higher returns, you have to understand that the risk will be higher than normally holding the corporate bond fund, which is medium if held for more than 2 years. The below table will give you a clear snapshot of which fund debt fund suits your requirement.
The writer is CEO – Sykes & Ray Financial Planners