The capital markets regulator has tightened rules on classification of mutual fund (MF) schemes and capped portfolio overlaps, leading to the immediate closure of a plan category, potentially forcing a consolidation of thematic investment choices, and likely causing a shrinkage in the returns on arbitrage funds.
“For easy identification by investors, to bring uniformity in scheme names for a particular category across mutual funds and to ensure they remain ‘true to label,’ scheme name shall be the same as its category,” the Securities and Exchange Board of India (Sebi) said.
It scrapped the solution-oriented schemes category, putting a stop to all such subscriptions with immediate effect.
Sebi stressed the need to delink investment plan names and returns. It said the ‘type of scheme’ description in offer documents and advertisements must adhere to a prescribed format. “Words or phrases that highlight or emphasise only the return aspect of the scheme shall not be used in the name,” it said.
Sebi has broadly classified schemes into five categories – equity, debt, hybrid, life cycle and other. The last includes fund of fund schemes and passive ones such as index or exchange traded funds.
Cos have Time to Comply
The regulator said no more than 50% of a thematic equity scheme’s portfolio must overlap with other thematic schemes and other equity categories, except for large-cap schemes. “Over a period of time, this could lead to some thematic funds, which may not have scaled, to be merged with similar schemes,” said Aditya Agarwal, cofounder of Wealthy.in, a platform for mutual fund distributors.
Sebi said thematic funds have three years to comply, while the others have six months. Schemes that are unable to meet the portfolio overlap criteria after three years would have to be mandatorily merged with other schemes, it said.
“Sebi has done something it rarely does – admitted a category was pointless and killed it. Solution-oriented funds were always a labelling exercise, and their removal is long overdue,” said Dhirendra Kumar, head of Value Research. “The overlap restrictions on thematic funds are also welcome. They force fund companies to prove their schemes are genuinely different, not just creatively named.”
New Product Category
The regulator also said asset managers could now introduce life cycle funds, while clarifying that foreign securities would not be treated as a separate asset class.
Asset managers have also been allowed to offer both value and contra funds, but the overlap between the two portfolios cannot exceed 50%.
“Arbitrage funds need to restrict debt exposure to only government securities with a residual maturity of less than a year. With arbitrage funds allocating up to 35% to debt, this along with the increase in STT (securities transaction tax) from April could bring down returns from the category by 30-40 basis points,” said the product head at a domestic fund house.
Flip Side
Some believe the regulatory latitude on allowing a new class of schemes could give confusing signals to the average saver.
“I worry that with one hand Sebi is simplifying, and with the other it’s handing the industry new avenues to proliferate – sectoral debt funds, life cycle funds, and an elaborate fund of funds matrix that reads like a regulatory spreadsheet, not an investor guide,” said Kumar of Value Research. “The average investor needs four types of funds, not forty. Every new category Sebi creates becomes an NFO (new fund offering) opportunity for the industry. The real question isn’t whether this circular is well-drafted, which it is. But two years from now, will we have fewer, clearer choices for investors, or just more sophisticated clutter?”
