SEBI Bites The Bullet; Forcefully Clamps Down On Number Of Mutual Fund Schemes

The Securities and Exchange Board of India in a circular released yesterday (6 October), bit the bullet and heavily clamped down on the number of open-ended Mutual Fund schemes that are presently available to investors today. Currently, investors face the daunting task of sifting through a few thousand Mutual Fund schemes operated by 42 Asset Management Companies, before making an investment.

Anecdotal evidence would suggest that the plethora of available choices add precious little value to investor portfolios, serving instead to confuse decision making and encourage frequent churning in and out of funds based on short term past returns – usually to their detriment.

“There is a need to bring in uniformity in the characteristics of similar type of schemes launched by different Mutual Funds. This would ensure that an investor of Mutual Funds is able to evaluate the different options available, before taking an informed decision to invest in a scheme”, the circular stated.

The Mutual Fund Advisory Committee (MFAC) of SEBI released a list of five categories of funds, namely – Equity, Debt, Hybrid, Solution Oriented Schemes, and Other Schemes. Within these broad heads, further categories have been defined. Examples of Equity Fund categories are “Multi Cap”, “Large Cap”, “Value Fund” and “Contra Fund”. Debt Funds have been divided into 16 categories, mainly based on the fund’s target Macaulay Duration (a measure of interest rate sensitivity). Similarly, Hybrid Schemes have been broken down into 6 categories.

The circular, applicable to open-ended funds, clearly states that “only one scheme per category will be permitted”, except for Index Funds, Funds of Funds, and Sectoral Funds.

What this essentially means is that AMC’s will need to “wind up, merge or change fundamental attributes” of some of their funds to bring their number of schemes per category in line with SEBI’s issued guidelines. Per the circular, only 10 Equity Funds, 16 Debt Funds and 6 Hybrid Funds would be permitted. Given that many of the country’s top AMC’s currently run between 2 and 3 times that number of schemes per category, this would represent a significant change for them.

AMC’s have been given two months to submit proposals, and a further three months “post-observation” of these proposals to implement the necessary changes.

Fund Management Teams – cuts ahead?
Intuitively, it would seem that scheme consolidation will reduce the need for manpower within fund management teams of AMC’s, as each fund usually has a dedicated team of research associates, a Fund Manager, and in some cases, a Co-Fund Manager manning it. This might bring down expense ratios of these funds in the longer run, to the benefit of investors.

The death of the open ended NFO
The implementation of these guidelines will collaterally mark the death of the NFO; for open ended funds, at least. After all, an AMC will be permitted to launch a new fund only in the event that it doesn’t already have one running in a specific category. NFO’s have long stood to confuse investors, many of them continuing to harbour the fallacious belief that they make better investments as they are launched at a “low NAV” of Rs. 10. With NFO’s going out of the window, AMC’s will need to focus more on long-term performance if they’re to grow their AUM, as that will become the sole influencer of future inflows and business growth.

Operational Challenges
Registrars such as CAMS and KARVY face a daunting task. They will be required to re-work their complex databases, processes and systems to account for these changes, while ensuring that investors checking their portfolios through distributor portals continue to have a seamless investment experience. It’s likely to be a rough ride.

End Note

In the long run, this move will help clean up a number of schemes, uncomplicate the decision-making process, and benefit investors. As Mutual Funds continue their steady transition to becoming the preferred investment avenue for the ‘Aam Aadmi’, such moves on the forward-thinking regulator’s part may temporarily disrupt the status-quo, but will benefit the entire ecosystem in the long run. As Anil Ambani said recently, “Mutual Funds can grow 10-fold in the next 5 years”. Such explosive growth needs to necessarily be accompanied with suitable checks and balances to be sustainable.