Category: Investment Management




We hear a lot about mutual funds being the best investment option for long term and a critical instrument in beating the rising inflation in media these days. There is a common idea that it is one of the best tool to get exposure to the capital market, which is true in case of the investors who lack the time and expertise to do research on the capital market. Most of the times, people are advised to invest for long term so that the investments can give good returns to meet all their financial goals. Unsurprisingly, the question most of the investors want answered is which scheme to choose considering the enormous number of schemes and undefined categories available in the market.

The market regulator Securities Exchange Board of India (SEBI) has now come up with some measures which will help investors in picking the right scheme for them. SEBI has introduced categorisation and rationalization of schemes which will help define the characteristics of a scheme and made it compulsory that each fund house should hold only one scheme in each category. Though this is beneficial for both current and new investors, the new measures have brought in a lot of fundamental changes in the existing schemes which will also have an impact. Here, we will look at the changes that were brought in by the SEBI and what should be the factors an investor should be looking at for investing in a mutual fund.

Recent Changes

On Oct 6th 2017, SEBI put forward a constructive frame for the whole Mutual Fund industry through its circular on the categorisation and rationalisation of mutual fund schemes. The circular gives a clear cut definition to lot of parameters and attributes of the schemes that confused the investors for this long. It also gave a clear definition on the market capitalisation and the different characters of each category and their difference and avoiding some special words in the name of the schemes which only confused the investors. This was not a single day affair, the regulatory has been asking the fund houses to do this for quite a long time, which they had not followed.

As per the circular, the whole mutual fund industry was categorised into broad 38 categories, which included 11 equity categories, 16 debt categories, 7 hybrid categories, 2 solution oriented categories and 2 on others. The characteristics of each category and its fundamental framework were also clearly defined, which brings clarity to each category and thus benefits the investors.

This compelled the fund houses to make fundamental changes in their existing schemes as per the circular. The regulatory has given the fund houses time till the end of June 2018 to make the essential changes in their schemes and given a prescribed date for each fund house starting from March within which they should re-balance their portfolio. The fund houses have made a lot of fundamental changes in most of their existing schemes through portfolio rebalancing, merger of schemes and restructuring of the schemes, while for some, it was a mere name change.

Impact of categorisation on fund selection

Changes in the market capitalisation

The first step SEBI had taken in the fund categorisation and rationalisation was to realign the categorisation of market cap of a company. The listed companies in equity market are broadly classified into Large-cap, Mid-cap and Small-cap companies depending up on their market capitalisation and the shares of those companies are classified as Large-cap shares, Mid-cap shares and Small-cap shares. There were no clear cut definition for this categorisation of companies, the commonly used system was the slab system of market cap of the company. The commonly used slab was

Market capitalisation more than Rs. 20000cr – Large-cap companies

Market capitalisation from Rs.5000cr -Rs.20000cr- Mid-cap companies

Market capitalisation Rs. less than 5000cr – Small cap companies


Rather than this there were some new interpretations like Giant-cap companies and tiny-cap companies on the cap categorisation.

As the first step, SEBI had advised Association Of Mutual Funds of India(AMFI) to issue a list of market capitalisation of all the tradable shares in Indian market and ranked them in terms of full market capitalisation and categorise them accordingly. AMFI says that large-cap stocks are the 1stto 100thcompanies in terms of full market capitalization. While mid-cap stocks comprise of 101stto 250th companies, small-cap stocks consist of beyond 250thcompanies in terms of full market capitalization. This list will be prepared on a half-yearly basis on Dec and June of every year and will be published before 6th of the next month. The first list was published on the first week of Jan 2018. In this new list, the market cap of the 100thcompany(i.e. the last company on the Large-cap list ) was more than Rs.290000cr, whereas the 250th company(last company of Mid-cap list) is more than Rs.8500cr, which led to the change in the category of some shares.


Fund reconciliation

Before the process of categorisation and reconciliation, most of the big fund houses were holding more than one fund in the same category for eg:- Prudential ICICI was having 3 funds in the large-cap category. It was very difficult for the common investors to differentiate between each fund as the portfolio differences were mere. This made a confusion in the mind of investors while selecting the funds which suits his risk profile.

With the new guideline, SEBI has insisted that the fund houses can hold only one fund in one category with some exceptions in some categories. The definition of each category were well defined which reduces the confusion and give clarity to the investor to invest according to his risk profile. The fund houses have either merged their funds or reconciled the portfolio of the funds according to the new guidelines.

Changes in Risk Returns analysis

When we do mutual fund analysis, we usually look at the past performance of the fund by evaluating the different attributes of the funds, mainly the risk and return for a specific period. The process of fund valuation has now become strenuous after the new guidelines of SEBI as the past data for the new categories are not available.

Even though the process has given clarity on the categorisation of the funds, still some confusions prevail for the investors as well as the analysts, as the current funds may change to one of the 3 categories detailed below:


1) Only name change or no change in the fund name as well as the fund fundamentals

2) Merging/consolidation of an existing fund with another fund

3) A total change in the name, fundamentals as well as the category of a fund


1) Only name change or no change in the fund name as well as the fund fundamentalsThese are the funds which are least affected by this process. The changes on these funds may be limited to a name change, as the circular has specified on usage of certain words on the fund name. As there is no fundamental change on funds, the past data of returns and risk will still have relevance on the fund and can be used for the analysis purpose.


2) Merging/consolidation of an existing fund with an another fund

These are the funds that a fund house holds which have very similar fundamentals, but categorised on different categories earlier. After the process of Categorisation and rationalisation of the mutual fund, either one of this fund will be closed or merged into another fund which has similar fundamentals or get consolidated to create a new fund.


In this case, the SEBI had given clear guideline on calculating the performance of these funds on its circular dated 12-04-2018.

• When two schemes having similar features get merged and the new scheme also has same features, the weighted average performance of both the schemes needs to be disclosed.

• When two schemes (A and B) are merged and features of either scheme A or B is retained, then the performance of the retained scheme should be disclosed.

• When two schemes (A and B) merged and a new scheme C emerges after such consolidation or merger of scheme, then there will be no past performance and the performance need not be disclosed.

The return and risk parameters as per the SEBI guidelines may be used to analyse the fund’s performance with its peers on the same category.


3) A total change in the name, fundamentals as well as the category of a fund

In such a case, there will not be any past data on performance as well as the risk pertaining to a particular fund. In such case, the analysis of these funds may be avoided due to non-availability of past data.

Changes in the Expense ratio

Mutual funds typically incur two types of expenses – the non-recurring expenses during the launch of a fund, which are usually borne by the fund house in India, the other is the recurring expenses such as the management fee, distributor’s commission, registrar’s fee, trustee fee and marketing expenses. These expenses are totalled and called as Total Expense Ratio (TER). Before the SEBI guidelines came, the TER of the funds were disclosed on a daily basis and the expenses ratios on a monthly basis in the website and fact sheets.

As per the SEBI guideline, the maximum TER that a fund can charge its investors on an Equity Fund is 2.5%. This cap is set lower for debt and index funds at 2.25% and 1.5% respectively. The guideline further set sub-limits to the TER depending up on the size of AUM. For equity schemes, fund houses can charge 2.5% for the first Rs.100Cr, 2.25% for Rs.100Cr to Rs.400Cr, 2% on the next Rs.400Cr to Rs.700Cr and 1.75% on any sums above Rs.700 Cr. For debt schemes, the limits are 25 basis points lower in each slabs. There may be some additional expenses which will go to a maximum of 52 basis point or 0.52%. This shows that fund houses can charge up to 3.02 per cent and 2.77 per cent in equity funds and debt funds, respectively.

Form the above, we can understand that as the AUM of the fund increases and the average expense ratio of the fund reduces. So, due the rationalisation and categorisation, a lot of small funds have merged with large funds on the same category which have reduced the expense ratio to the investors who were holding those small schemes.


Changes in the benchmark returns calculation

The mutual fund usually discloses its returns on certain percentage; this return will be compared with the benchmark that fund follows to understand the performance of the fund. SEBI on its new guidelines have mandated that the bench mark returns for the mutual funds should be calculated on the Total Return Index(TRI) basis. The shift from plain vanilla index to TRI is supposed to give a clearer picture of the scheme performance versus its benchmark. The current benchmark indices are exclusive of dividends whereas the TRI includes the dividends by the indices also. Thus making TRI an index which will track both the capital gains of a scheme and assumes that any cash distribution, such as dividends, are reinvested back into the index.

With TRI coming in to picture, the fund managers should have to put more investment strategies to make his fund outperform the index which will benefit the investor on long term.


Factors existing investors should be considering after categorisation

Look for the ratios

The investors should look for the different risk reward ratios like Standard deviation, Beta, Sharpe, Information ratio etc. to understand the performance of the funds. These ratios also give an outlook on the fund manager’s performance when comparing the benchmark. The investors should look at the changes on these ratios and realign their portfolio if required after the categorisation.

Rebalancing of funds as per your risk profile

After the process of categorisation and rationalisation, a lot of funds have moved from their existing category to a new category, which had effected on some changes on the fundamentals of the fund. The changes in the fundamentals have compelled the fund management team to realign the portfolio as per the guidelines requirement which may effect in the change of risk parameter of the fund. The investors have to look at the portfolio changes and realign their portfolio depending on the risk profile.


Transparency on fund portfolio

The market regulatory on its circular has clearly mentioned that each fund category has to be clearly defined and the same has to be communicated. The percentage holding of each market cap for each equity category was also defined clearly. This has given a clear cut idea for the investors on what type of fund he is holding and his exposure towards each market cap.

In the case of debt fund, they follow two strategies: duration and accrual. Duration funds benefit from interest rate movements, whereas accrual funds earn regular income from corporate bonds. Prior to this guidelines, the maturity of funds was not defined. This made it difficult for investors to track the fund’s performance. But now, transparency has improved as the fund’s portfolio duration should be aligned within the limit specified for each category.



After the SEBI guidelines, most of the fund houses have realigned their funds and portfolio. SEBI has clearly advised the fund houses that the changes on the portfolio has to be clearly communicated to the investors on email and ample time should be given to the investors to exit the fund without any charges if he wishes so.

By taking this step, the market regulatory has improved the transparency of the whole industry, which will help in attracting new investors to this market. Most of the fund houses have realigned their portfolio as of now and the impact of this will be shown in the coming days. The investors can look for this and invest accordingly.

For More details on fund categorization research data at Dilzer please see Reco Funds – Review – Re-CategorizationJun2018


Dilzer Consultants Pvt Ltd


Different SEBI Circulars on fund Categorisation and rationalisation, Total Expense Ratio (TER) and Benchmark returns