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Categorisation and Rationalisation of Mutual Fund Schemes by SEBI

Swetha Dhinesh
07 Mar, 2023 07 Mar, 2023
Mutual Fund Schemes

The schemes a mutual fund introduces should be clearly distinguished from one another in terms of asset allocation, investing approach, etc. Also, there is a need to standardise the traits of comparable sorts of schemes introduced by various Mutual Funds. It would guarantee that a mutual fund investor has the ability to assess the various possibilities before making a well-informed choice to invest in a scheme.

The problem was discussed in the Mutual Fund Advisory Committee[1] (MFAC) to bring about the desired uniformity in the practice across Mutual Funds and standardise the scheme categories and characteristics of each category. 

Recategorization of Mutual Funds

A customer’s capacity to select a mutual fund that best suits his needs and circumstances should be made simple by SEBI. The regulator claims that AMCs use these names as marketing strategies to attract clients, and many of the new customers could not fully understand the programme. Thus, SEBI expects mutual fund firms to differentiate between various plans regarding asset allocation and investing approach. The regulator also seeks to establish consistency among comparable plans introduced by other mutual funds so that buyers can compare goods more easily.

Because of this, in its circular mutual fund classification from October 6, 2017, SEBI not only established the types of schemes but also described each scheme. The regulator required fund houses to divide all of their current and upcoming projects into five main categories and 36 subcategories.

Five major categories of Mutual Fund schemes

  1. Equity Schemes
  2. Hybrid Schemes
  3. Debt Schemes
  4. Solution-oriented schemes
  5. Other schemes

Equity Schemes 

A mutual fund company is only allowed to have ten categories and must select between value and contra, even though SEBI has determined that there are 11 categories under equity schemes. Still, ten categories seem excessive, but it is reasonable to have potential differences in the strategy. To help with this, SEBI has also clarified what Mid Cap, Large Cap and Small Cap are.

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S.No.Category of SchemeCharacteristicsDescription of the scheme
1.Mid-cap fundAllocates 65% of total assets to equities and securities related to mid-cap companies.A publicly traded equity fund that mostly invests in mid-cap Stocks.
2.Small-cap fundAllocates 65% of total assets to equities and securities related to small-cap companies.Broad equities investment plan with a focus on small-cap Stocks.
3.Large-cap fundPut 80% of entries assets into large-cap company equities and related securities.A fund that is open-ended and mostly invests in large-cap stocks.
4.Multi-cap fundInvesting 65% of total assets in equity and its related securities.An open-ended equity fund that primarily invests in large, mid, and small-cap equities.
5. Large & mid-cap fundsNeed to allocate 35% of total assets to equity and related securities of large-size companies and 35% to equity and related securities of mid-cap companies.A plan for open-ended equity investments that mostly buy large and mid-cap equities.
6. Dividend-yield fundsHave to place a large portion of their assets in the dividend-yielding fund and at least 65% in equity.A plan for open-ended equity investments that focuses mostly on dividend-paying stocks.
7a.Value fundIt should use a value investment approach and allocate 65% of total assets to stocks and other securities that are related to stocks.An open-ended equity programme that uses the value investment approach.
7b.Contra fundAdopting a contrarian investment approach and allocating 65% of total assets to stocks and securities that are relevant to them.An open-ended stock plan using a contrarian approach to investing.
8.Sectoral/Thematic fundAllocates at least 80% of total assets to investing in equity and securities that are related to it in a specific subject or industry.A plan investing in equities that is open-ended (name of the theme or sector).
9.Focused fundAllocates 65% of total assets to equities and securities that are tied to it. It should emphasise the number of stocks (a maximum of 30 stocks).An open-ended equity fund that buys up to 30 stocks (mention where the scheme intends to focus, viz, multi-cap, large cap, mid cap, small cap).
10.ELSSAllocate 80% of total assets to stocks and other equity-related securities (in accordance with Equity Linked Savings Scheme 2005 notified by the Ministry of Finance).An open-ended equity-linked savings plan with tax benefits and a three-year legal lock-in.

Debt Schemes

A total of 16 categories for debt schemes have been decided by SEBI. Sixteen categories is a high number for debt funds, especially when you consider how close their risk and returns are to those of retail investors. Overnight Funds and Liquid Funds are two similar categories. The same is true for the categories of money market and ultra-short-term debt funds.

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S.No.Category of SchemesCharacteristicsDescription of the Scheme
1.Large-cap fundMake investments in debt and money market securities to keep the portfolio’s Macaulay duration between 6 to 12 months.A low-duration open-ended debt investment strategy that invests in assets with Macaulay durations of six to twelve months. 
2. Ultra-short duration fundShould make investments in debt and money market securities to keep the portfolio’s Macaulay duration between three and six months.A plan that invests in securities with a Macaulay duration of between three months and six months.
3.Liquid fundOnly invest in debt and money market assets within 91 days or less of maturity.An open-ended liquid scheme.
4. Overnight fundInvesting in short-term assets with a one-day maturity.A debt strategy that invests in overnight securities.
5. Short duration fundMake investments in debt and money market securities to keep the portfolio’s Macaulay duration between one and three years.A short-term debt investment strategy that is open-ended that invests in securities with Macaulay durations between one and three years.
6. Medium duration fundMake investments in debt and money market securities to keep the portfolio’s Macaulay duration between three and four years.An open-ended medium-term debt investment strategy that targets securities with Macaulay durations of three to four years.
7.Money market fundShould invest in securities with a maturity of up to one year in the money market.A long programme that invests in money market securities.
8.Medium to long duration fundMake investments in debt and money market securities to keep the portfolio’s Macaulay duration between 4 and 7 years. A Medium-term debt open-ended programme that invests in securities with Macaulay durations of between 4 and 7 years.
9.Long-duration fundInvestments in debts and money market securities so that the portfolio’s Macaulay duration is more than seven years.A debt fund that is open-ended invests in securities with a Macaulay term of a least seven years.
10.Corporate bond fund80% of total assets have to be allocated to the best-rated corporate bonds.A debt strategy that invests in the best-rated corporate bonds.
11.Dynamic FundShould make a variety of investments.A Dynamic debt investment strategy with an open end.
12.Banking & PSU fundShould allocate 80% of total assets to debt instruments issued by banks, government agencies, and public sector undertakings.An unregulated debt fund that invests in the debt securities of public sector undertakings and banks.
13.Credit risk fundAllocate 65% of total assets to the corporate bonds with ratings below investments grade.A debt investment strategy that invests in corporate bonds with ratings below the highest.
14.Floater fundShould allocate 65% of total assets to floating rate securities.An open-ended financing programme that invests mostly in variable-rate securities.
15.Gilt fundPut 80% of your money into government bonds.A debt programme with no fixed expiration date that invests in government assets.
16.Gilt fund with 10 years constant durationAllocate 80% of total assets to government securities, resulting in a portfolio with a 10-year Macaulay duration.An open-ended debt strategy that invests in government securities with a fixed 10-year maturity.

Hybrid Schemes

A mutual fund business is limited to 6 categories and must pick between the balanced hybrid fund and the aggressive hybrid fund out of the total categories that SEBI has determined for hybrid schemes. Moreover, SEBI has classified arbitrage funds as hybrid funds.

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S.No.Category of schemesCharacteristicsDescription of the scheme
1. Aggressive Hybrid FundMust allocate between 65% and 80% of total assets to equity and securities related to it and allocate between 20% and 35% of total assets to debt securities.A hybrid open-ended investment plan that invests in both debt and equity instruments.
2. Balanced Hybrid FundAllocate between 40% and 60% of total assets to debt securities and between 40% and 60% of total assets to equity and its linked securities. Arbitrage will not be permitted.  A flexible, open-ended investment strategy that balances equity and debt securities.
3.Conservative Hybrid FundAllocate 10% to 25% of total assets to equity and securities related to it. 75% to 90% of total assets should be allocated to debt securities.A hybrid open-ended fund that invests mostly in debt securities.
4.Dynamic Asset Allocation or Balanced Advantage FundShould buy dynamically managed debt or equity securities.A dynamic asset allocation fund that is open-ended.
5.Multi-Asset Allocation FundAllocate a minimum of 10% to each asset class and invest in no less than three different asset types.An unrestricted plan investing in (names of the asset classes).
6.Arbitrage FundShould use an arbitrage strategy and put at least 65% of their money into stocks and other securities that are related to stocks.A plan with no end that invests in arbitrage possibilities.
7.Equity savingsAllocate at least 10% of total assets to debt securities and at least 65% of total assets to equity and its linked securities.A plan with no end that invests in debt, stock, and arbitrage.

Solution-Oriented Schemes

S.NoCategory of Schemes CharacteristicsDescription of Schemes
1.Children’s Fund5 years minimum lock-in duration, or until the child reaches majority age, whichever comes first.An open-ended investment vehicle with a minimum 5-year lock-in period or until retirement age, whichever comes first.
2.Retirement FundA minimum 5-year lock-in period, or until retirement age, whichever comes first.A retirement solution-focused open-ended plan with a 5-year lock-in term or till retirement age ( whichever is earlier).

Other Schemes

S.No.Category of SchemesCharacteristicsDescription of Schemes
1.Index Funds/ ETFsPut at least 95% of all assets into securities that correspond to a specific index.An open-ended plan for monitoring/ replicating (name of the index).
2.Fund of Funds (Overseas or Domestic)At least 95% of the total assets must be put into the underlying fund.An open-ended fund of fund strategy that invests in (name of the underlying fund).

Impact of Categorisation and Rationalisation of Mutual Fund Schemes by SEBI

Investors’ minds will be made clearer by SEBI’s categorisation and rationalisation of mutual fund schemes, which will also make it easier for them to choose a fund that meets their investment needs. We have outlined below how the categorisation has affected the mutual fund industry as a whole.

Shuffle in portfolios – Many current schemes’ portfolios will need to be reorganised, which will inevitably cause short-term agitation in the mutual fund industry.

Improved awareness of risk – Due to the clearly specified characteristics of each scheme, investors can now match their return expectations with their level of risk tolerance to determine which fund they should invest in.

Reduced mis-selling – The categorisation of products will reduce mis-selling because, in the past, many investors were tricked into participating in schemes that did not suit their needs. Now, even inexperienced investors may recognise, understand, and choose the best fund for their needs.

Rise under Assets Under Management (AUM) fund – Assets under management of the fund will rise as a result of the new categorisation, which will result in the merger of numerous schemes. This is due to the fact that the target plan will consolidate the assets of the previous scheme. As a result, fund managers will need to use their knowledge to manage the scheme’s rapidly increasing asset base.

Short-term results could be affected – Many funds would need to reshuffle their assets in order to comply with SEBI regulations. This would lead to a larger turnover, which would then have an effect on the short-term returns provided by the funds.

Conclusion

Overall, the SEBI decision to reclassify mutual funds is a positive step. It forces fund managers to present investors with a distinct value proposition genuinely. The new categories may cause short-term disruption, but they are a step in the direction of educating investors and introducing uniformity to the mutual fund business in the long run.

Also Read:
How Does a Mutual Fund Operate?
Procedure for Mutual Funds Registration in India
Registration and Regulation of Mutual Funds – SEBI

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