SEBI Multicap MF Rule: Are other fund categories “true to label”?

Published: September 19, 2020 at 10:59 am

On Sep 11th 2020, SEBI modified asset allocation rules of multicap mutual funds claiming that these funds have not remained “true to label”. They then released an additional clarification that the flexibility to invest across market cap does not mean funds could ignore small caps. What was SEBI’s motive behind this rule? Or was it to fix a fund category that was not “true to label”? Is this the only category that is not “true to label?” A discussion.

SEBI’s claim that multicap funds “had the flexibility” to invest across market cap but failed to include enough of small caps is devoid of all reason. As AUM gatherers, mutual funds would like to preserve it too. A multicap with excessive mid or small cap stocks would become significantly currently more volatile (the bottom few stocks of the NIfty 100 are essentially mid cap in terms of their impact cost).

To accuse mutual funds of failing to be “true to label” when the initial categorization rules gave them that flexibility can only be seen an excuse to bolster the small cap segment. BSE Small cap index may have recovered more than the Sensex but it is still 20% shy of its Jan 2018 all-time-high.

SEBI’s action has worried investors with several of them asking if this would affect ELSS funds, focused funds etc. The majority of mutual fund investors are not ready to handle the volatility of small caps when the market crash of Mar 2020 is fresh in the memory. This naturally begs the question, if multicap mutual funds are not true to label, what about other fund categories?

Take, for example, the value fund category or contra fund category. There is no way one can check if these funds are “true to label” when the definition of what is a value pick or contra pick is arbitrary. One can argue that by definition a value-buy is a contrarian choice. Typically value-oriented funds are expected to have low portfolio PE.

If you inspect this quantity in the Aug 2020 factsheets, UTI Value Opp Fund has a PE of 37.6 and Templeton India Value Fund 21.1. The rest of the funds range in between. The PE of the three contra funds (only 3 because a fund can either have a value-fund or contra-fund) are much higher. Are they contra-funds or growth funds?

Yes PE is not a good enough indicator of contra, but what is? The point here is if the regulator is so worried about funds not being “true to label”, then how can they or we the investor make this out? Other than market capitalization (which in of itself is arbitrary – to classify Nifty Next 50 as a large cap index fund is a joke) there is no other definite way.  Dividend yield can be used to classify Div Yield funds but this is too arbitrary.

SEBI says a focused fund (with a 30-stock portfolio) should declare itself as large, mid, small or multicap. So does the new rule mean a multicap focused fund will have 8 stocks each of large, mid and small caps?

Consider equity savings category. This was supposed to be an arbitrage fund with some bond and “small equity” exposure. It was created when the LTCG duration of debt funds was extended to three years in 2014. However, the SEBI classification norm just says 65% in equity and the scheme has the flexibility to decide the arbitrage exposure. So naturally, there is a huge variation in the category.  For example 11% derivative exposure in Mahindra equity saving fund and 33% in PGIM’s equity savings fund.

Will SEBI – after first providing the flexibility – then change it claiming funds are not being “true to label”? After all, this much variation in asset type allocation in a category referred to “savings” can only mislead investors with respect to risk perception.

The solution-oriented schemes for retirement and children have no portfolio restrictions aside from a lock-in. The point I am trying to make is, if there is flexibility, fund houses will use it. To claim this is not being true to label and pick on one category, in particular, makes no sense and most importantly it affects investors.

Debt mutual fund classification also suffer from problems: The money market segment – overnight, liquid and money market (!) categories are defined in terms of bond maturity. The rest are defined in terms of Macaulay duration which very few investors or advisors understand. Then we have the corporate bond, credit risk and banking and PSU categories with no restrictions on duration.

When the scheme rules do not achieve the intended objective of “uniformity in the characteristics of similar type of schemes”, for several categories, why pick on multicap funds alone?

If SEBI wanted MFs to participate more in small caps, they could have introduced a new category with the “25% of each” rule. Fund houses always hungry for a quick AUM “fix” would have joined the queue for launching NFOs. That would have got the job done for SEBI without worrying existing multicap investors and disrupting their portfolio structure.

Do share if you found this useful

Did you know? We have more than 900+ videos on YouTube to explore! Join our YouTube Community!

Use our Robo-advisory Excel Template for a start-to-finish financial plan!

Join our courses in exclusive Facebook Groups!

  • 500+ members are now part of our new course, How to get people to pay for your skills! (watch 1st lecture for free). Learn how to get people to pay for your skills! Whether you are a professional or small business owner wanting more clients via online visibility or a salaried person wanting a side income or passive income, we will show how to achieve by showcasing your skills, building a community that trusts you and pays you!
  • 1822 members have signed for Goal-based portfolio management (watch 1st lecture for free). This is an online course to reduce fear, uncertainty and doubt while investing for a financial goal. Learn how to plan for your goals before and after retirement with confidence.

Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
We publish mutual fund screeners and momentum, low volatility stock screeners on a monthly basis
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman 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. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association, IIST Alumni Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this 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 Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis 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

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new 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 Rs 199 (instant download)
Free android apps