Mutual Funds – New Categories and What They Mean To You 

It’s not easy to choose a fund from 2000+ mutual fund schemes in the market. The mutual fund industry has been known for providing a large number of schemes with similar investment goal for some time now. Earlier, for example, the definition of Mutual Fund Categories (Large Cap, Mid cap, Small cap) was not defined by SEBI. Fund houses used to pick and choose allocations basis their discretion.

This led to,

1. Investors getting confused with so many options – An investor looking to invest in a Large Cap Fund from Axis Mutual Fund got confused when he found that there were two funds available with similar looking stocks in the portfolio. Both these funds had Large Cap stocks in its portfolio ( Large Caps are Top 100 stocks with market cap of Rs 10,000 cr+)
2. Investors who invest in mid-cap or small-cap funds are aggressive investors and expect higher returns. Fund houses to avoid market volatility shifted its allocation to large-cap funds leading to higher returns getting compromised.

To improve Investor services, SEBI allowed 1 scheme per category. For example, if a fund has been classified as Large Cap, then it has to mandatorily invest in top 100 Blue chip companies. These Large Caps are stable and have a high cash reserve on their balance sheets. These investors can rely on fund’s objectives being used as a benchmark now.

SEBI now has specified 36 categories of mutual fund schemes and every Mutual Fund house can only have one fund for each category.

There is also a clear classification now, from SEBI, about the large cap, mid cap and small cap:

• Large Cap Company: Top 100 companies trading in stock markets
• Mid Cap Company: Between 101- 250 trading in stock markets
• Small Cap Company: Companies beyond 250th company in terms of full market capitalization.
• Multi-Cap Funds: These schemes will continue to invest across large Cap, Mid Cap and Small Cap stocks.
• Dividend Yield Funds: This is a new category introduced by SEBI. The schemes under this category will invest in dividend yielding stocks or stocks that pay periodic dividends.
• Value Funds: The schemes in this category will follow the value style of investment. These schemes are mandated to maintain a 65 per cent allocation to equities. Value investment style is where the fund manager bets on stocks that he/she believes are undervalued.
• Contra Funds: These schemes will follow the contrarian investment strategy and have a minimum 65 per cent allocation to equities. In the contra style of investing, the fund manager takes a contrarian view.
• Focused Funds: These schemes will invest in a maximum of 30 stocks. The scheme would mention which market cap it tends to focus (multi-cap, large cap, mid cap, small cap).
• Sectoral/ Thematic Funds: These schemes, as the name suggests, will invest in a particular theme or a sector. These schemes will have to invest a minimum 80 per cent of their assets in equity. Sectoral or thematic funds are generally considered risky for retail investors because their fortunes depend on the performance of a particular sector.
• ELSS (Equity Linked Saving Schemes): ELSSs are tax-saving mutual fund schemes with a lock-in period of three years. Their minimum investment in equities should be 80 per cent of the total assets.

Post-re-categorization, Debt Funds now have 16 Categories defined, as outlined below.

These funds take into consideration interest rate risk and credit risk of an underlying portfolio. The new category, very precisely, defines the tenure or type of debt instruments – floating notes, gilts, treasury bills, etc. that a fund invests in. For example, a short-term duration fund can invest in a scheme with a maturity of 1–3 years, while a medium duration fund can invest in securities with a duration of 4–7 years.

In Balanced funds, earlier the proportion of stocks and bonds were not defined, post-re-categorization the same has been standardized into different categories:

1) Conservative Hybrid Fund: These schemes are called conservative since they invest predominantly in debt instruments. Post-re-categorization, these schemes will invest approx 75 to 90% of their total assets in debt instruments and 10 to 25% in equity-related instruments.

2) Balanced Hybrid Fund: Balanced Hybrid Fund is a balanced scheme investing in debt and equity instruments, in which equity and debt instruments are between 40% and 60% of the total corpus. 40% being equity and 60% debt or vice versa.

3) Aggressive Hybrid Fund:  This is an open-ended hybrid solution investing primarily in equity, in which equity allocation needs to be between 65–80% of total asset and debt allocation must be between 20–35%.

4) Dynamic Asset Allocation Funds: Dynamic asset allocation funds, as the name suggests, automatically rebalances their portfolios on the predefined model. They automatically reduce the exposure to pure equity as the markets become expensive. Simultaneously, they also increase their exposure towards arbitrage and debt which limits the downside risk in a stock market crash.

5) Arbitrage Funds – Arbitrage funds are hybrid mutual funds that seize arbitrage opportunities in the cash and derivative market. A large portion of the investment is made in the debt segment. Arbitrage hybrid funds have lower equity taxation as well as lower volatility. There is risk associated with these funds.

Recategorization by SEBI has made comparisons easy and has allowed people to actually invest in schemes based on their goals and risk appetite. New, as well as seasoned investors, will thus have a better grasp and understanding of what they’re investing in.