One Year of Re-Categorisation: Looking back

Last year around this time, SEBI had come out with standardised categories for funds to follow. That meant existing funds also had to fit into one of the categories. With funds merging, changing names and moving to other categories, there was quite a lot going on. We had called out how the re-categorisation process would affect funds and guided you on structuring your portfolios given the changes. As funds settle into their new categories, we decided to look at how the changes have played out.

Broadly in most funds and categories, the changes in terms of either market cap (for equity) or duration and credit risk (for debt) have remained minimal. The maximum change has happened either in entirely new categories, or where funds’ old and new categories were drastically different. Here’s what’s new.

New introductions

Large-and-midcap was an entirely new category. Several entrants to this category were earlier multi-cap in nature. But though the mandate of this category resembles multicaps, funds previously didn’t have to compulsorily hold 35% in large and midcaps each. Therefore, funds had to tweak their allocations to comply with the requirement. Currently, funds in this category are mostly largecap oriented with over 50% of their portfolio in largecaps. Even funds like Mirae Asset Emerging Bluechip and Principal Emerging Bluechip which took opportunistic midcap calls have now increased their largecap exposure. Whether this overall large-cap tilt is due to fund strategy or the steep mid-cap correction last year remains to be seen.

Focused, value, and dividend yield are new categories. But, barring focused, funds that slotted themselves here were already following the same strategy. Besides, with no clear guidelines on how SEBI defines these strategies fund houses could simply carry on as before. Focused funds as a strategy prevailed even before. But as a category itself, it was novel because the funds were restricted to hold a maximum of 30 stocks only. Funds like Sundaram Select Focus and Motilal Oswal Focused 25 could comfortably move into this category. But there were others like Aditya Birla Sun Life Focused Equity (formerly Aditya Birla Sun life Top 100) that had to heavily prune the number of stocks from around 50 stocks last year. Market cap wise, most funds in the category put themselves in multicap focused because of its flexibility. But their current portfolios are tilted more towards largecaps. Again, whether this is because of market corrections remains to be seen.

Floater and money market funds are entirely new because funds did not stick to specific instruments earlier. Money market funds were mostly ultra-short and liquid funds which already held high proportion in CPs and CDs. Even so, some had to bring down their exposure to short-term corporate bonds to make space for more money market instruments. Floater funds have to invest in floating rate papers. Given the lack of adequate floating-rate bonds in the market, funds are using interest rate swaps to fulfil this criterion.

NFOs have ballooned, contrary to our expectations. While the expectation was that re-categorisation will lead to consolidation, fund houses actually found opportunities to launch new funds. The large number of categories and the introduction of entirely new ones resulted in many AMCs having gaps in their fund basket. Therefore, they began launching schemes as opportunities opened up. Most launches came in hybrid category with lesser known strategies like equity savings and balanced advantage gaining traction. Overnight funds is also one such category where new funds were launched instead of converting existing schemes. The large number of categories also ensured that mergers were fewer in number.

What’s the challenge?

The entire recategorization exercise was meant to rationalise fund offerings. It was to make it easier for investors to know what the nature of a fund was, before investing in it. So, has recategorization helped? In a way, yes. Funds – both equity and debt – could change colour based on market opportunities. A short-term fund could take duration calls, an income fund could take credit calls, a multicap fund could become a mid-cap and vice versa, a large-cap fund could become a multicap. What the recategorization exercise has brought in is more predictability to what funds can do. Now, with funds clearly demarcated into categories, there won’t be any surprises in the fund strategies. And that means, no unexpected changes in your portfolio risk.

Equity

But in other aspects, recategorization hasn’t helped. Consider the multicap category. Given their accommodating mandate, there was an influx of other category funds into this. Since funds didn’t need to make any changes to their strategy, they continued to do the same despite category change. For example, HDFC Equity fund was largecap before and still continues to hold over 80% in largecaps. UTI Equity was an aggressive large-cap fund and has only marginally increased mid-cap allocation. Invesco Multicap, formerly Invesco Mid and Small cap, continues to have a mid and small cap concentration. Funds here still have varied ranges of market caps.

And thus, their risks are vastly different though they all belong to the same category. The same goes for large-and-midcap funds, value funds, dividend yield funds, and focused funds. The difference in market cap allocations among funds changes their risk levels despite being in the same category.

Debt

Similarly, the sheer number of categories debt funds are classified into is nothing less than intimidating for an average investor. Further, many new categories are based on the duration of the portfolio and nature of the instruments. There is no definition of credit risk outside of the corporate bond and credit risk categories. Therefore, funds are still all over the place in terms of credit quality. The risk profile of different categories becomes very fund specific. The medium duration category, for instance, has funds where credit risk ranges from nil to 80%.

For funds defined by credit risk of the instruments, the range of average maturities is vast. In the corporate bond category, duration ranges from 1-1.5 years all the way up to 8 years. We had waited to see if the funds in the category aligned to a similar maturity range – with the rate cycle heading lower, this is a good time to see if funds in the corporate bond category played around with maturities. This doesn’t seem to be the case. Therefore, different funds will have different volatility and return levels depending on their duration.

Bottomline – recategorization has ensured that funds don’t arbitrarily change nature depending on the market. But challenges in fund selection and understanding fund risk within a category remains as before.