How mutual fund selection is affected by Sebi’s Mutual Fund Categorization rules

Last Updated on

Most readers may be aware that SEBI has laid out norms for mutual fund categorization and many AMCs have fallen in line. It is frustrating that the big AMCs like ICICI, HDFC, Franklin and others have delayed conforming to this order. Makes me want to speculate that they have deliberately waited for the financial year to end to avoid mass switching or redemption. In this post, I discuss why and how mutual fund selection is affected by these rules and what existing investors should do if a scheme announces a fundamental change in attribute.

For the record, HDFC has announced the changes for their debt funds on March 28th. If you are an investor, you will get an email. If you an enthusiast, you can look in the downloads (addendum) or news sections of the amc websites for details. If you are wondering what these regulations are, you can start here: SEBI’s Mutual Fund Scheme Categorization: Pros and Cons. These are the relevant circulars: SEBI circular no. SEBI/HO/IMD/DF3/CIR/P/2017/114 dated October 6, 2017 and circular no. SEBI/HO/IMD/DF3/CIR/P/2017/126 dated December 04, 2017 on “Categorization and Rationalization of Mutual Fund Schemes”.

How do these rules affect mutual funds?

The investment mandate, strategy, asset allocation and benchmark of several funds have changed. This is known as a change in a fundamental attribute. When this happens, as per SEBI rules, the fund house must provide a load-free exit option to unitholders. Many funds have been merged because SEBI now allows only one fund per category.

How do these rules affect existing investors?

Since it is a fundamental change in attribute, the AMC will offer existing investors a time window to exit without load (but tax is applicable as usual). If no action is taken by the investor, then the scheme will either be merged with another, the scheme name changed or the mandate changed as declared by the AMC. In most cases, the risk profile of the new scheme is not different from that of the old. So existing investors will not be affected too much. If the very nature of the fund has changed or will be merged into a different fund, then investors must consider the exit option on a case by case basis. When you review performance, keep this change date in mind.

How do these rules affect mutual fund selection or new investors?

In on stroke, these rules have made past performance irrelevant, be it returns, risk, downside protection, alpha, Sortino, etc. Anything that can be calculated with the NAV is no longer relevant IF the fund has changed its nature – asset allocation, strategy or benchmark. In other words, from the announced date of change, we will be looking at a new fund.

Trash mutual fund star ratings because of SEBI categorization rules

This means, from that date, star ratings are more useless than they already are. Why? Because star rating is a peer comparison. When the many members in a peer group change colour, you cannot use ratings that rely on past performance. It simply make no sense to look at star ratings and choose a fund (it never did) when the fund’s future management is different from what it was in the past. This is the reason why I did not publish my monthly risk-reward consistency screener last month. This month, I shall only publish it for funds that have not changed investment strategy.

Even if you are die-hard star ratings fan, please recognise that it will take the next 3-5 years for funds in the new category to be compared and rated. So this is the best time to ditch them. Read more: Mutual Fund Star Ratings are Flawed, but Investors are to blame for taking them at face value

Which funds have not changed because of this SEBI categorization?

There are two varieties here: (A) Funds for which the AMC has clearly mentioned that there will be no change. For example, PPFAS Value Fund, All funds of Quantum, most funds of MOST and Mirae. Any more? Please comment below. (B) There is a change in strategy, asset allocation or benchmark, but these changes do not seem significant. Again this has to be decided on a case by case basis and this choice is purely qualitative. So you will have to take a deeper look.

So how should I now select mutual funds now?

The key steps have not changed. Define your need —> Decide asset allocation —-> Decide on product categories with new rules (within a month all AMCs should have complied)—-> Shortlist a set of funds from a select category based on their past* downside protection consistency —-> Look at the changes to each fund in the shortlist  and pick one you are comfortable with. There is not much else you can do.  * For now, the past will have to be prior the categorization rules. But this will change with time.

Does the mutual fund review process change now?

No. Once you make a selection or if you are an existing investor, use the new benchmark as primary outperformance yardstick and the old benchmark as second outperformance yardstick. Never look at star rating changes as they look at a different time window than that of your investment. Always look for consistent outperformance in return and downside with both benchmarks from the date you started investing in the fund. If there are reasonable, nothing more need be done – other than vary asset allocation as per need and manage risk in the portfolio. Read more: How to review a mutual fund portfolio

Other points to consider

Check if these star rating portals have bothered to comply with SEBI fund classifications. If they have not, do not take the grouping seriously. Even if they do, never ever compare peers. This is a waste of time and energy and will only stress you out.It will take several months for things to settle down. So do be patient.

Do share if you found this useful

About the Author M Pattabiraman author of freefincal.comM. Pattabiraman(PhD) is the author and owner of freefincal.com.  He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Pattu” as he is popularly known, has co-authored two print-books, You can be rich too with goal based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management.  He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. Pattu publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year (2.5 million page views) with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis. He conducts free money management sessions for corporates  and associations(see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. Contact information: freefincal {at} Gmail {dot} com (sponsored posts or paid collaborations will not be entertained)
Want to conduct a sales-free "basics of money management" session in your office?
I conduct free seminars to employees or societies. Only the very basics and getting-started steps are discussed (no scary math):For example: How to define financial goals, how to save tax with a clear goal in mind; How to use a credit card for maximum benefit; When to buy a house; How to start investing; where to invest; how to invest for and after retirement etc. depending on the audience. If you are interested, you can contact me: freefincal [at] Gmail [dot] com. I can do the talk via conferencing software, so there is no cost for your company. If you want me to travel, you need to cover my airfare (I live in Chennai)

Connect with us on social media


Content Policy

Freefincal has original unbiased, conflict-of-interest-free,  topical reports, reviews, commentary and analysis on all aspects of personal finance like mutual funds, stocks, insurance etc. All guest authors and contributors to the site also do not have any conflict of interest. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. No promotional content We do not accept sponsored posts and link exchange requests from content writers and agencies. This is our privacy policy Our website is non-profit in nature. The revenue from the advertisement will only be used for hosting charges, domain registration charges, specific plugins necessary for traffic growth and analytics services for search engine optimisation.

Do check out my books


You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingMy first book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.  It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You WantGamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantMy second book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

The ultimate guide to travel by Pranav Surya

Travel-Training-Kit-Cover This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.  Get the pdf for ₹199 (instant download)

Free Apps for your Android Phone

All calculators from our book, “You can be Rich Too” are now available on Google Play!
Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.

5 Comments

  1. If a fund has exit load in case of redemption within x years, will the clock get reset if it merges with a new one (assuming redemption outside of the free exit load period)?

  2. Mutual Fund Categorisation rules are OK by SEBI, at this juncture they also should stream line the uniformity in providing the account statements. Each AMC is having their own style of presenting their statements. It is becoming hard to find out and check the details they provide. Why don’t we insist on this point with SEBI. Specially new entrants, who are not well versed about the account statements are finding it difficult.

Leave a Reply

Your email address will not be published. Required fields are marked *